Owning a home comes with many ups and downs. If you can manage to sell it at a profit, it makes the additional maintenance costs, home improvements, and insurance and tax payments worth the effort. Additionally, if you've inherited a property or received one as a gift and plan to sell it, you may have profits coming your way. Understanding how to calculate your cost basis and any potential capital gains on the property will give you an idea of how selling it could impact your tax obligation.
Defining Capital Gains
The Internal Revenue Service defines capital gains as any excess money you make on the sale of a property over and above its adjusted cost basis. The original cost basis of your property is the amount you paid for it. Figuring out the adjusted cost basis involves documenting costs associated with several events that may occur while you own the house, such as capital improvements, home additions and casualty losses.
Determining Adjusted Cost Basis
In general, improvements that increase the value of the home or prolong its life increase the cost basis of the property. Room additions and system upgrades add value to the property, and are deductible on your taxes when you sell it if the improvements are still in place. Insurance payments you receive to bring the property back to its original condition decrease your cost basis. For a comprehensive list of improvements that increase your cost basis review IRS's Publication 523.
Capital Gains Exclusions
The IRS lets you deduct up to $250,000 in capital gains if you're single or $500,000 if you're married filing jointly. The property must be your primary residence for two of the last five years prior to the sale in order to use this capital exclusion. In many cases you may not have any taxable capitals gains as a result of the exclusion unless you've lived in the home for several years and it's appreciated significantly in an expensive real estate market.
Investment Property Rules
If you're an investment property owner, you get to deduct the cost of many repairs and capital improvements in the year you make them through allowed deductions and depreciation. Finding your adjusted cost basis may be less straightforward, because the depreciation you took while you owned your investment property will decrease the cost basis. The IRS requires you to recapture a portion of the depreciation and deduct it from your cost basis.
Inherited and Gifted Property
Figuring the cost basis of inherited or gifted property is different than property you have purchased. The cost basis of an inherited property is determined by the market value of the property on the date you receive it. For gifted property, cost basis simply transfers ownership, and the previous owner's adjusted cost basis becomes your adjusted cost basis for the home.
Forms To Use
The IRS requires that you report capital property gains on Form 8949, Sales and Other Dispositions of Capital Assets. Include the date of purchase, original cost, date of sale, and the adjusted cost basis of the property. Report the capital gain or loss from Form 8949 on Schedule D, Capital Gains and Losses, of the 1040 tax form.
Monica Dillon has more than 10 years experience in real estate sales, marketing, investing and appraising. She specializes in energy efficiency building practices and renewable energy. Dillon has been syndicated by the National Newspaper Publisher's Association. Her work has also appeared in the "Journal Of Progressive Human Services."