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All About The Numbers
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Home, Sweet Home
March 12, 2021
Timely information is worth repeating! This blog was originally posted July 2020. With all the changes over this last year, including some home improvements, it may be a good time to review this issue.
For many, if you have lived in your house for a period of time, this asset may comprise a large part of your net worth. Knowing what the tax implications may be if you were to sell it, takes a bit of work. This blog should help you figure this out.
Have you lived in the same place for a while? Do you remember what you paid for your home? Have you done a few home improvements over the years? Do you have a record of what was done and how much these cost? Keeping track of home improvements can have important tax consequences when you sell your home. You may not be planning on doing this for a few years, but that shouldn’t stop you from getting a good accounting of your home’s Adjusted Cost Basis at the present moment. At some point, this will happen and taking the time now to thoughtfully reflect on this issue will pay dividends down the road for you and your loved ones.
Under current tax law, you can exclude a gain of up to $250,000 if you are a single taxpayer and up to $500,000 if you are married filing jointly. To qualify for the exclusion the ownership, residence, and look-back requirements must be met. The ownership requirement is met when the home is owned for at least 24 months out of the last 5 years leading up to the date of the sale (closing date). For married couples filing jointly, only one spouse has to meet the ownership requirement. The residence requirement states that the home must be owned and used as primary residence for at least 24 months of the previous 5 years. The 24 months of residence can fall anywhere within the 5 year period and does not have to be a single block of time. The look-back period states that another home wasn’t sold during the 2 year period before the date of sale and the exclusion was taken. There are some exceptions to these rules and they are noted in IRS Publication 523.
You may think you are well under either of these thresholds and in good shape. However, having good records to support your position may be needed if the IRS comes knocking. If providing this information is left up to your loved ones, it may put them in a difficult position. A bigger issue we see is related to couples that have seen their homes greatly appreciate over the years. If one of the couple dies, the surviving spouse’s exclusion now drops from $500,000 to $250,000 if the house is not sold within two years of the date of death. So knowing where you stand now becomes an important calculation. If your capital gain is greater than the exclusion amount, it will be taxed as either a short-term or long-term gain.
Let’s start by identifying the four items you will need to report a gain if you were selling your home. Three of these are pretty straight forward: 1) the date you purchased it, 2) the date it would be sold, and 3) the sale price. The fourth item may take a bit of time to construct and it is the primary reason we felt this blog needed to be written, determining your Adjusted Cost Basis. It starts with what you paid for your home (Original Basis). Then you add any expenses or fees incurred to purchase your home (such as legal, title abstract, recording, survey fees, to name a few) to arrive at your Cost Basis. At this point you then need to construct a time table of any home improvements (Adjusted Cost Basis) you have made to your property. If there are any leans against the property, such as a mortgage or HELOC, they are subtracted from your Adjusted Cost Basis.
So let’s take a deeper dive into what comprises home improvement costs. Improvements are deemed to be costs over and above what may have already been there. In other words, if you replace vinyl gutters, the value of the existing gutters is already associated with the original value of the house. If the new gutters are copper and of greater value than the vinyl gutters it is replacing, it is the difference in cost between vinyl and copper gutters that can be added to our Adjusted Cost Basis, not the total purchase price of the copper gutters. So this is where determining Adjusted Cost Basis can get tricky. The cost of items used to replace or improve is different than adding the cost of new additions to your Adjusted Cost Basis.
So having said this, here are some improvements to consider and include;
1. Additions – bathroom, bedroom, deck, garage, porch or patio.
2. Lawn & garden improvements – landscaping, driveway, walkway, fence, retaining wall, swimming pool, lawn sprinkler system.
3. Exterior improvements such as storm windows and doors, upgraded roof or upgraded siding.
4. Interior improvements such as built-in appliances, kitchen modernization, upgraded flooring, upgraded wall-to-wall carpet and fireplace.
5. Insulation improvements– attic, walls, floors, pipes and duct work.
6. Systems – heating, central air condition, furnace, duct work, central humidifier, central vacuum, air/water filtration systems, wiring, security system.
7. Plumbing – septic system, water heater, soft water system, filtration system.
Improvements that can’t be included are;
1. Any cost of repairs or maintenance that are necessary to keep your home in good condition but don’t add to its value or prolong its life. For example, painting,(interior & exterior), fixing leaks, filling holes or cracks, replacing broken hardware.
2. Any costs of improvements that are no longer part of your home. For example, wall-to-wall carpeting that you installed but later replaced.
3. Any costs of any improvements with a life expectancy, when installed, of less than 1 year.
The IRS Publication 523 “Selling You Home” provides more detailed information. It also provides a good worksheet to calculate your home’s Adjusted Cost Basis.
Calculating your home’s Adjusted Cost Basis may seem like an intimidating process initially, but it can also provide a fun trip down memory lane. Once you have calculated your Adjusted Cost Basis and subtracted this from a projected sale price you will have a good understanding of what your gain may be and in turn, if you are within the exclusion amount. This document you have created to track your Adjusted Cost Basis can then be updated as needed and should be kept in a secure place where others are aware of its existence. In addition to this document showing a timeline of dates and what was done or purchased, you also need to maintain the supporting information such as receipts, proof of payment, etc.
This material is distributed by Alexander Financial Planning, Inc. (AFP) and it is for information purposes only. Although information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy. It is provided with the understanding that no fiduciary relationship exists because of this report. Opinions expressed in this report are not necessarily the opinions of AFP and they are subject to change without notice. AFP assumes no liability for the interpretation or use of this information. No portion of this writing should be construed as legal or accounting advice. All rights reserved.
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