What Expenses Are Deductible in Selling a House?

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DISCLAIMER: This blog post is meant to be used for educational purposes only, not legal advice. If you need assistance navigating the legalities of tax deductions when selling a home, HomeLight always encourages you to consult your tax advisor.

Before most homeowners seriously think of putting their home on the market, they usually do some quick calculations to get a ballpark figure of their potential profit.

When you’re estimating the costs of the sale, taxes can be a big part of the equation. But, oftentimes, it’s challenging to project how taxes will impact your equity.

Even spending endless hours sifting through regulations on irs.gov doesn’t guarantee you’ll arrive at the right answer.

That’s because we often think of IRS Code as laws created by a higher power that are not to be questioned.

In reality, the laws’ complexity lends itself to a lot of nuance and interpretation, which can even confound the most seasoned tax professionals.

Daylong seminars are filled with certified public accountants (CPAs) and tax attorneys debating energy credits.

Book chapters are written about the latest changes to medical deductions.

And, ultimately, well-educated tax professionals may maintain different perspectives on the application of any section of the code.

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How can I estimate the taxes I’ll owe on my home sale?

To arm you with the most, updated, easy-to-understand information about home sales tax, we turned to the National Society of Accountants.

The NSA’s Tax Line Help Desk independent consultant Don Schippa has researched tax issues for CPAs, tax attorneys, and other clients/professionals for nearly 40 years.

In that time, “One of the real estate questions that comes across my desk the most relates to the IRS code section 121 home sale exclusion,” Schippa begins. “In other words, the biggest concern a seller has is: Is my gain non-taxable?”

His simple, no-nonsense approach to home sales tax is invaluable in helping you understand and anticipate the federal tax factors that are likely to affect your home sale profits.

Because the issue can be quite complex, we’ll start by answering some common questions.

Can I claim expenses related to the sale of my home the same way I claim other deductions such as medical expenses?

The first part of figuring out how much taxes affect your profit starts with understanding how home sales taxes differ from other deductions.

Many taxpayers are used to thinking about reducing their tax burden by lobbing deductions — eligible expenses — against their income and revenue from other sources to come up with what they owe.

If a family itemizes deductions on their 1040 form, medical expenses go on Schedule A along with contributions charitable contributions, mortgage interest, property taxes, and some miscellaneous items.

“There’s nothing else relating to a home that goes on that form,” Schippa says. “That mortgage interest and property taxes are the main deductions a principal residence has on an annual basis — even in the year of sale.”

What deductions apply in the year of a sale?

“This might come as a shock,” says Schippa. “There isn’t really, technically a ‘deduction,’ when you’re selling your personal residence.”

The deductions for a home the year of a sale are the same as any other year.

“There is literally no deductible expense that a seller of their principal residence can take that’s any different from when they were living in and owning the home,” Schippa explains, “They can deduct only prorated mortgage interest and property taxes.”

However, there are allowable exclusions on the proceeds from the sale of a principal residence, which we’ll address in a minute.

Are home repairs deductible?

Whether the homeowners are filing yearly taxes while living in the home or after a sale, the short answer is no.

“The IRS Code 262(a) says the amount of taxpayer spending for repairs, and upkeep is a nondeductible personal expense from which a taxpayer derives no tax benefit,” Schippa explains.

So, maintenance costs such as painting, yearly HVAC inspection, lawn mowing kid or service, and replacing a toilet are considered personal expenses, which are non-deductible.

Can I apply depreciation?

“Residences are a personal asset, and depreciation is a business deduction on an income-producing asset,” says Schippa.

For example, if you make repairs to a rental property, they could potentially be deductible or depreciable.

However, personal residences don’t depreciate, so deductions cannot be claimed through the Modified Accelerated Cost Recovery System (MACRS).

Taxes on the sale of a primary residence are calculated differently.

How does the IRS tax a home sale?

Taxes are based largely on the amount of capital gain — the profit the homeowner makes after the cost basis (the sellers’ total investment in the home) is deducted from the sales price.

Beyond that, “There’s a simple principle that’s kind of a bombshell,” says Schippa. “Section 121 Exclusion grants the sellers of a personal residence the ability to exclude up to $500,000 of gain from being taxable if they are filing jointly or up to $250,000 if the taxpayer is filing individually.”

Those exclusions apply regardless of the tax bracket. The main condition is: The sellers must have lived in the house two out of the last five years.

So, Schippa says, “To benefit from the exclusion, you don’t have to necessarily be living in the home when you sell it.”

To explore the way the exclusion works, let’s say your friends are a married couple in their 40s, who are selling the house they bought 15 years ago for $200,000.

They’ve been living abroad for the last two years and renting the property. But, now, they’ve decided to relocate to London permanently.

With the improvements they’ve made over the years, they’ve got a basis of $300,000.

Because they’re working with a knowledgeable HomeLight real estate agent, the property sells for $700,000. That means their $400,000 gain is non-taxable.

Likewise, you’re helping an elderly aunt sell her house, so she can transition to yours or a retirement community. She bought the house for $35,000 in 1960 and put on an addition in 1980 for $35,000.

Your aunt has kept a meticulous, well-maintained home, and millennials are eager to snap up any available property in her neighborhood.

Her agent says $15,000 in updates could increase the home’s value by $50,000 and result in a sale of around $150,000.

Because you’ve confirmed the Realtor®’s calculations by using HomeLight’s home value estimator, you’re not surprised when the house closes at $152,000.

Now, your aunt has great cash flow to cover her move. Even better, there’s no tax implication. Her gain — $67,000 — is not taxable because it does not exceed $250,000.

You can only exclude home sale profits from capital gains tax once every two years.

How Much Will I Make Selling My Home?

With HomeLight’s free Net Proceeds Calculator, you can estimate the cost of selling your home and the net proceeds you could earn from the sale.

What happens if the capital gain totals more than the Section 121 exclusion?

On the tax return, capital gains appear on Form 8949 or Schedule D.

“The typical taxpayer will pay no more than a 20% tax on gains exceeding the tax-exempt $250,000 or $500,000,” says Schippa.

So, if your friends sell that same house for $1 million, they’ve got a $700,000 gain.

IRS Code Section 121 allows them to exclude $500,000; however, the remaining $200,000 gain is taxable. It could cost them up to $40,000 — unless they have receipts for eligible expenses to add to their cost basis.

Is there a way to reduce the tax burden on the taxable part of the proceeds?

Homeowners can reduce the taxable portion of their capital gains — profits that exceed the tax-exempt threshold — by adding the cost of substantial home improvements made during the entire time of ownership to their cost basis.

Small home repairs cannot be applied to reduce the tax burden.

However, looking at your friends’ $700,000 gain, suddenly the receipt for a $15,000 roof replacement that hadn’t been added to their basis becomes very important.

Once it’s added to the basis, the $200,000 gain goes down by $15,000. Subsequently, they save $3,000 (20% of $15,000) in taxes just with that one receipt.

What’s the difference between a home repair and a home improvement?

In terms of the expenses that can be added to the cost basis to decrease capital gains in home sales, home improvements are generally eligible; home repairs typically are not.

Typically, “A repair is more attributed to maintenance,” Schippa says. “An improvement is attributed more to some substantial addition to the house or substantial repair or betterment.”

However, sometimes, repairs can rise to the level of improvement.

Impressed by the profit your aunt realized and her happiness with her new living situation, her brother — your uncle — asks you to work the same magic, so he can move. The property values in his neighborhood are also skyrocketing.

His house and lot are large. He hasn’t done much upkeep since he retired. Since he’ll be living in the house until it sells, he’s nixed the idea of a full renovation. But, he will let you make repairs, so the house is more attractive to buyers.

You turn the stoop into a wrap-around porch, install crown molding, replace the shutters, upgrade the security system, replace the stairs, replace the cabinet doors, improve the yard’s hardscape to increase accessibility, drainage, and curb appeal.

In three months, you’ve hired eight different contractors and spent a total of $22,000.

Lightning strikes twice and you sell the home your uncle bought for $80,000 for $350,000. While $250,000 of the profits are non-taxable, the remaining $20,000 is.

However, if you kept the receipts, you can capitalize the $22,000 in expenses. Then, all the funds become a non-taxable gain.

“Individual small repairs cannot be added to the cost basis,” Schippa explains. “but a series of aggregated small repairs that result in an improvement over time might be considered.”

So, again, you emerge from the closing as the family’s real estate hero.

Are there any other expenses that can decrease the taxable amount in addition to the capital gains exclusion?

Another way to increase the cost basis and decrease tax burden over the threshold is through other eligible expenses.

As far as the costs involved in the sale of the home, some can be used to reduce capital gains.

In general, many of the closing costs and agent commissions can be used to reduce capital gains.

However, most marketing expenses are excluded.

Some typical kinds of expenses that can be capitalized include:

  • Closing costs including broker commission
  • Abstract fees (abstract of title fees)
  • Charges for installing utility services
  • Legal fees (including fees for the title search and preparing the sales contract and deed)
  • Recording fees
  • Survey fees
  • Transfer or stamp taxes
  • Owner’s title insurance

Some expenses that do not reduce capital gains include:

  • Staging
  • Marketing
  • Yard signs
  • Photography
  • Moving expenses
  • Any costs of repairs or maintenance (fixing leaks, replacing broken hardware, etc.) that are necessary to keep your home in good condition but don’t add to its value or prolong its life
  • Any costs of any improvements that are no longer part of your home (i.e., wall-to-wall carpeting that you installed but later replaced)
  • Any costs of any improvements with a life expectancy, when installed, of less than 1 year

Where can I go to find out specific items that can be added to cost basis?

Visit your new best friend — IRS Publication 523.

It’s a great reference for finding out whether particular items (solar panels, fixing/replacing a carbon monoxide detector, etc.,) can be deducted from capital gains.

In addition, “Publication 523 has nice little worksheets and lists of the various expenses that are lists of items,” Schippa says. “It can help taxpayers figure out the questions they need to ask their preparer.

What’s the best way to make sure I’ve made the most of eligible items in my cost basis?

Really the best way to minimize your tax burden and maximize your profit potential is to work with a local tax preparer.

“One tax preparer’s repair is another professional’s improvement,” says Schippa.

“Two tax professionals in the same city — or office — may apply the code very differently,” he continues. “Depending upon their perspective, how aggressive they are, the discussion with the client. And, they can both be right.”

Because there’s frequently a lack of consensus, some issues have been resolved in only case law.

In addition, each state has its own regulations regarding the taxation of gains from the sale of a home. That’s why it’s important to consult with a local tax professional for a complete picture of your tax profile.

However, you can always profit from understanding these simple truths about the complex IRS codes.

Header Image Source: (Hayley Bagwell / Unsplash)