Summer is typically a “hot season” in the home sale market. Young families typically want to get settled in a new home before school begins in the fall, and older homesellers in northern climates want to head south before winter sets in. Your clients who are buying a new home will need to do some serious number crunching to determine what they can afford to pay—and how they will pay it. However, your clients who are homesellers will need to do some number crunching as well.
Under current tax rules, a loss on a home sale is not deductible. On the other hand, the first $250,000 of gain on a home sale is excluded from income. What’s more, for joint filers, the exclusion is generally doubled to $500,000. However, for long-time homeowners, even those generous exclusions may not shelter all of their gain from tax. Therefore, they’ll need to—
Get back to basis
To properly determine gain (or loss) on the sale or exchange of a home, a taxpayer must know the basis of the home for tax purposes. And calculating basis will involve information that dates back to the time the home was purchased—or perhaps even earlier.
The amount of gain or loss on a sale is determined by comparing the amount realized on the sale to the adjusted basis of the home. If the amount realized is greater than the adjusted basis, the difference is a gain. If the amount realized is less than the adjusted basis, the difference is a loss [IRC Sec. 1001(a); Reg. 1.1001-1(a)].
In most cases, the starting point for determining basis is the cost of the home [IRC Sec. 1012]. If a home was purchased from the builder or from a former owner, the initial cost basis includes the purchase price and certain settlement costs. The purchase price generally includes the down payment and any debt, such as mortgage or notes given to the seller in payment for the home [IRC Sec. 1012; Reg. 1.1012-1(a)].
Settlement fees or closing costs associated with the purchase of the home can be added to basis. However, fees associated with a mortgage on the home (e.g., appraisal fees, costs of a credit report or mortgage insurance fees) are not added to basis. In addition, escrow amounts for payment of future liabilities are not included in the basis of the home. Examples of settlement fees that can be added to basis include:
- Abstract of title fees
- Charges for installing utility services
- Legal fees (e.g., fees for a title search and for preparing the sales contract and deed)
- Recording fees
- Survey costs
- Title insurance
- Transfer taxes
When a home changes hands, real estate taxes for the year of the sale are apportioned between the buyer and seller based on the number of days each of them held the property during the year [IRC Sec. 164(a)(1)]. The date of the sale counts as a day the property is owned by the buyer. Real estate taxes for the year of sale may increase or decrease basis, depending on how the taxes were handled at the closing. If the buyer paid taxes owed by the seller and was not reimbursed, the taxes increase the buyer’s basis of the home. If the seller paid taxes owed by the buyer and was not reimbursed, the taxes decrease the buyer’s basis of the home [IRC Sec. 1012; Reg. 1.1012-1(b)].
In the case of a home that was constructed by or for the taxpayer, basis includes the cost of the land plus the construction costs. However, if the taxpayer did all or part of the construction personally, basis does not include the value of the taxpayer’s own labor or the value of any other unpaid labor.
Basis other than cost
Special rules apply in determining basis if a home was acquired other than by purchase or construction—for example, as a gift or inheritance or as part of a divorce settlement. In addition, a taxpayer may have a basis other than cost if a home was acquired as a replacement home in a home-sale rollover under prior law.
Adjustments to basis
A taxpayer’s basis in a home is not static. Basis may be adjusted upward or downward to reflect expenditures made in connection with the home or payments or other benefits received [IRC Sec. 1016].
Improvements that increase basis include:
- Additions to the home, such an extra bedroom or bath, a family room, a deck or patio, or a garage.
- Landscaping and other outdoor improvements, such as a new driveway or walkway, fences and walls, a sprinkler system, or a swimming pool.
- Systems improvements, such as a new heating system, central air conditioning, a new furnace or ductwork, wiring upgrades, a septic system, a water heater or water filtration system, a satellite dish, or a security system.
- Exterior improvements, such as new storm windows or doors, roof, siding or shutters.
- Interior improvements, such as built-in appliances, kitchen cabinetry, flooring, wall-to-wall carpeting and insulation.
CAUTION: Improvements that are no longer part of a home are not included in the home’s basis.
Example: Joan Gordon bought her home for $200,000 in 2005. In 2006, Gordon added a deck to the home at a cost of $6,000. In 2012, Gordon remodeled the home, which involved removal of the deck and the addition of a new covered porch. The addition and porch cost $30,000. Result: After the addition of the deck in 2006, Gordon’s basis in the home increased to $206,000. However, after the deck was removed in 2012, it was no longer included in the home’s basis. Therefore, Gordon’s basis for the home following the remodeling is $230,000 ($206,000 – $6,000 + $30,000).
Examples of repairs that do not increase basis (unless they are part of an overall renovation or remodeling) include interior or exterior painting, fixing gutters, repairing leaks or plastering, and replacing broken windowpanes.
TAX TIP: For many long-time homeowners, calculating basis will mean digging through piles of old records and receipts. And even then, the number they come up with may be a “guesstimate.” You can help clients who are new to the housing market by giving them a list of items that are included in or will add to the basis of their new home. By tracking expenditures on an ongoing basis, they’ll be prepared when it is time to move on.
Editor’s note: This article first appeared on the Intuit® ProConnect™ Tax Pro Center. For more tax tips on selling a home, read “How Selling a Home Can Impact Your Clients’ Taxes” on the Intuit® ProConnect™ Tax Pro Center.