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Selling Your Home: Understanding Capital Gains Taxes

If you’re considering selling your primary residence, you may be wondering if you’ll owe capital gains taxes on the profit. The answer is yes, but the amount you’ll owe depends on several factors.

How Capital Gains Taxes Work

The IRS treats a home sale as a gain or loss on an investment. If you’ve owned the property for at least a year, you’ll pay capital gains rates on your profit. The good news is that you only pay taxes on your profit, which is calculated by subtracting the adjusted cost basis of the property from the sale price.

Adjusted Cost Basis: What’s Included?

The adjusted cost basis includes the initial purchase price of the home, plus any value added through improvements, such as:

• Interior remodeling, like redoing your kitchen
• Internal updates, like improving the furnace or windows
• External additions, like adding a new room
• Some legal fees, agent fees, and other sales costs

However, repairs do not contribute to your home’s adjusted basis, nor do interest payments on the mortgage.

Section 121 Exclusion: A Tax Break for Homeowners

If you sell your primary residence, you may be eligible for a Section 121 exclusion, which allows you to exempt a certain lifetime amount of profit from taxes. Single taxpayers can exclude the first $250,000 of capital gains, while married taxpayers can exclude the first $500,000.

Calculating Your Taxable Gain

To calculate your taxable gain, you’ll need to subtract the adjusted cost basis of the property from the sale price, then reduce your profit by your exemption amount. The remainder is your taxable gain.

Long-Term Capital Gains Rates: What You’ll Pay

Long-term capital gains rates range from 0% to 20%, depending on your income and filing status. However, any gain that exceeds the exclusion limit may also be subject to the net investment income tax (NIIT), a 3.8% tax that kicks in at various income thresholds.

Example: Calculating Capital Gains Taxes

Let’s say you’re married, filing jointly, with a household income of $150,000, and you’ve owned and lived in your house for five years. You sell your home for a $750,000 profit. After applying the Section 121 exclusion, your taxable gain would be $250,000. Assuming a 15% capital gains rate, you’d owe $37,500 in taxes.

Factors Affecting Your Tax Bill

Several factors can impact your capital gains tax bill, including:

• Marital status
• Total household income
• Duration of ownership
• Previous use of lifetime exemption
• Adjusted cost basis

Seeking Professional Guidance

Selling a home can be a complex taxable event. Consider consulting a financial advisor to help you navigate the process and minimize your tax liability. With the right guidance, you can make informed decisions about your financial future.

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