How Do You Calculate Capital Gains Taxes When You Sell Your Home? (Part 1 of 3)
Before you can calculate the capital gains taxes on the sale of your home, you must first understand basis. The examples below are for illustrative purposes only. For a complete understanding and a full review of your specific situation, contact an Orange County Estate Planning Attorney at Modern Wealth Law.
What is the Basis in Your Home?
The basis in your home is what you paid for your home. So assuming you buy your home in 2014 for $500,000, your basis in your home is $500,000. Pretty simple, right? Well it’s not quite that simple, but pretty close. Your basis is the purchase price ($500,000), plus purchase expenses, plus the cost of capital improvements, minus any depreciation and minus any casualty losses or insurance payments. As your home grows in value, your basis generally stays the same unless you improve your home (remodel).
Why is understanding basis important?
How Do You Calculate Capital Gains?
A capital gain is the difference between your basis and the higher selling price of your home. Let’s use the same example from above:
You buy a home in 2014 for $500,000 (your basis). Now let’s assume in 10 years you sell your home for $1,200,000. You have made $700,000 on the sale of your home ($1,200,000 – $500,000 = $700,000). The $700,000 is considered capital gains, minus any amount paid for closing costs and selling costs.
You should note, if you refinance your home and take a portion of that money out to spend on other things, you will not pay taxes at that time. However, when you sell your home you will have less equity in your home, but the same basis. This results in the same capital gains even though at the time of sale, you received less money in your pocket. This is better understood through the following example:
Let’s use the same $500,000 home you bought in 2014. Fast forward to the year 2023 and the value of your home has increased to $1,000,000 and you refinance your home and take out the excess cash. The following year, you sell your home for $1,200,000. Assuming these facts, you will have $200,000 in equity ($1,200,000 – $1,000,000 = $200,000). However, you will still have the same basis in your home and have $700,000 of capital gains. Of course, this makes sense since you took out a bunch of cash just a year earlier. But if you have since used that cash, you may be in a situation where your tax bill is higher than the amount you receive at the time of sale.
Now that we know how capital gains are calculated when you sell your home, let’s look at how those capital gains are taxed.
How Do You Calculate Capital Gains Tax?
Capital gains are subject to a 15% tax or more depending on your income. Capital gains are also subject to state taxes, with the amount varying from state to state. Using the same example from above, assuming $700,000 in capital gains and a 15% tax, you will owe $105,000 in federal taxes when you sell your home.
There are certain exemptions that you may use to avoid paying capital gains tax. For more information on how to avoid these capital gains taxes, please read How to Avoid Paying Capital Gains When You Sell Your Home.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
