The Downside of Watching Your House Rise in Value: Capital Gains Tax

buying-home-selling-your-house“Did you hear how much that house down the street just sold far?!” If you live in a place like the Bay Area of California, that’s a sentence you’ll hear repeated at every neighborhood gathering — usually followed by details about what a fixer-upper the place was, how many offers came in, and how many tens of thousands over asking price it actually sold for.

Then everyone goes a bit quiet, secretly calculating, “If that dump went for over a million, then my place must be worth . . . WOW!”

Yes, it’s fun to be back in a time of home appreciation. Such rises in value haven’t happened in every part of the U.S., but in the places where they are happening — such as in the cities of New York, Los Angeles, San Francisco, Boston, and San Diego — the numbers are truly eye-popping.

As soon as your home appreciation goes over $250,000 (for individual homeowners) or $500,000 (for married homeowners filing jointly), however, the fun is tempered by a look down the road, as you remember capital gains taxes. Real estate gains like these catapult you right over the IRS exclusion, into a world where you might actually owe a chunk of change when you sell.

This issue was recently pointed out by Ron Lieber of The New York Times, in an article whose title offers the best advice around: “House Value Jumping? Save Your Home Improvement Receipts.” According to Lieber’s research, 3.8% of single homeowners and 1.2% of married homeowners already need to worry about paying capital gains tax upon sale, based on their home’s appreciation since they purchased.

But, as Lieber also reminds us, home appreciation isn’t as simple as merely subtracting your purchase price from your sale price. You can reduce your “profit” by factoring in (among other things) the money you poured into improving your home along the way. As Nolo’s Stephen Fishman further explains, “The cost of home improvements are added to the tax basis of your home. “Basis” means the amount of your investment in your home for tax purposes. The greater your basis, the less profit you’ll receive when you sell your home.”

But you’ve got to be able to prove the amount you spent on improvements. The IRS auditor isn’t going to be impressed by you pointing to your lovely new kitchen countertops if you don’t have the receipts to back it up. See “Tax Reasons to Keep Good Records of Home Improvements” for details on what records to keep.