Disclaimer: Information in this blog post is meant to be used for educational purposes only, not as tax or legal advice. If you need help navigating the finances of your home sale, HomeLight always encourages you to reach out to your own advisor.
Homeownership is a great path for building wealth — especially as of late. According to Black Knight, a longstanding real estate and mortgage analytics company, annual home price growth has seen a 25-year average of 3.9%. What’s more, a report from CoreLogic shows a $26,300 boost in average homeowner equity in 2020 alone, marking the fastest year of price appreciation seen in the U.S. since 2013.
This strong history of property value gains has put many Americans in a position to sell their home for a tidy sum. But first-time sellers may wonder: What happens when you sell your house for a profit? How do you handle the escrow process and settle up at closing? Will you owe any taxes? And how should you spend the money left over that you haven’t already earmarked for expenses?
While it will be exhilarating to cash in a huge check, closing on a house requires managing a ton of details — all while you embark on a huge life change. “It can be emotional for a seller who has lived in a house for many years,” says Scott Freeman, a longtime real estate agent who sells 86% more single-family homes than the average agent in Riegelsville and southeastern Pennsylvania. “But it should be a fun time with no surprises.”
To avoid stress during what should be a celebratory moment, have a plan for when the “sold” sign appears on your property. We’re here to help with these five steps you can expect to take when you sell your house for a profit.
1. Have a neutral go-between to safely disburse funds
After you sign the purchase agreement with the buyer of your home, you won’t immediately see the profits. Your home first enters the escrow process, a holding period that can last 30-60 days. During this time, a third party safely holds any deposits that need disbursing in a separate account to avoid any conflict of interest.
Some states require that a real estate attorney serve as this third party. In states where an attorney is not required at closing, other professionals (such as an escrow title company, settlement agent, or real estate agent) will handle closing responsibilities like title transfer and drafting closing documents. Regardless, individual buyers and sellers can elect to have an attorney with them to review any documents or represent their interests.
The escrow period ends once this third-party disburses all funds at closing, including paying off any principal and interest owed on your existing mortgage through the closing date.
2. Pay off remaining fees and expenses related to the sale
Speaking of disbursing funds, your mortgage isn’t your only financial obligation when selling a home. Depending on your price range, you could spend 9% to 10% of the sale price on closing costs and fees. These may include and are not limited to:
- Real estate agent commissions (5.8% national average)
- Title fees
- Transfer or excise taxes (rates will vary by state)
- Escrow fees
- Reconveyance fee
- Recording fees
- Prorated property taxes
Depending on where you live, you might notice additional fees such as paying for a notary and public utilities, such as sewer and water, through the date of the sale, Freeman says.
It’s estimated that the average cost to sell a house in 2021 is over $31,000, not including a seller’s mortgage payoff, according to a recent study conducted by HomeLight. However, because many home sale fees are calculated ad valorem as a percentage of property value, the typical cost to sell a house can increase significantly in cities with higher-than-average home prices.
At the settlement table, your real estate agent will present you with an itemized list of your expenses and final payout. You may hear this document referred to as a closing statement, settlement statement, or the “ALTA sheet,” short for the ALTA Settlement Statement from the American Land Title Association.
3. Check if you qualify for the capital gains tax exclusion
Because a home is a capital investment, you are likely wondering whether you’ll owe capital gains taxes when you sell your home for a profit. However, the general tax rule is if you’ve owned your home for the past two years and lived in it for two of the past five, you qualify for the capital gains exclusion granted to homeowners for their primary residence. You can find additional and direct guidance through IRS Topic 701: The Sale of Your Home.
Here’s a quick way to calculate whether you’ll owe any capital gains taxes, courtesy of Nathan Rigney, a lead tax analyst at H&R Block:
- Do you qualify for the ownership and use tests? If so, move to the next step.
- Figure out your basis. Take the original purchase price you paid when you bought the home and add the cost of any capital improvements since you’ve owned it. (Make sure you have all receipts.)
- Subtract your basis from the current sale price. That gives you your “capital gain” in the eyes of the IRS.
Now, do you file your income taxes as a single person, or as a married couple filing jointly?
- If you’re single, you can exclude up to $250,000 in profit.
- If you’re married and filing jointly, you can exclude up to $500,000 in profit.
Note that the title company will report any gain or profit above those figures to the IRS, leaving you to pay capital gains taxes when you file your tax return, Freeman says. The amount of capital gains taxes that you pay depends on your tax bracket.
Bear in mind: You also won’t qualify for the exclusion if you’ve sold a home during the two years prior to this sale, according to the IRS. Talk with your accountant about reporting any profit from your home sale, which may involve Schedule D (Form 1040).
4. Make it final with your autograph
The buyer of your home will typically sign the bulk of the paperwork at closing, but sellers will have a few important documents to review as well. In addition to the closing statement, you might need to sign off on the following:
- A closing disclosure, which outlines loan costs if you offered to pay any of the buyer’s fees for obtaining a loan.
- The affidavit of title, which stipulates that you have the sole right to sell the property, as well as outlines any legal issues, such as outstanding liens that need to be cleared before the sale can close.
- The deed to your home, which officially transfers ownership to the buyer and is recorded with your county’s public legal documents.
- A bill of sale, which denotes any items of value you’re leaving to the buyer, such as window treatments, appliances, or patio furniture.
You might be able to sign whatever’s required remotely, though some states still require an in-person notary for certain documents.
5. Any money left over is yours to keep!
“After everything is paid, the balance of what’s left over is the seller’s proceeds. The seller is given a check at the settlement table, or the money is wired into their account,” Freeman says.
So, what comes next? Freeman has noticed several ways that sellers divvy up their profits.
“Some people, if they’re fortunate and have other living arrangements and are not directly having to buy a new home, sometimes it goes to retirement,” he says. “Sometimes it goes to Disneyland. It can be an exciting time if that money’s not already called for.”
Here are a few options for what to do with your proceeds.
Put it toward your next down payment
If you’ve sold your primary home, chances are, this is your first and best option. “Most people, when they sell a primary residence, take the funds and reinvest it into their next house,” says Chris Carter, who ranks in the top 2% of 2,633 real estate agents in Jackson County, Missouri.
Freeman has worked with clients who sold their former home in the morning and bought a new one that afternoon, with the proceeds going directly to another title company.
Invest it to make more money
If you have another primary home already, you might use your profit to purchase an investment property to rent — or you can invest it in stocks or bonds to make your money work for you. If that sounds intriguing, talk with a stockbroker or other financial advisor about the best investment options.
Spend with an eye on the future by eliminating debt
You naturally might want to celebrate your success over a fancy dinner or other splurge. But if you have outstanding loans, medical bills, or credit card debt, the profit from your home sale could give you some much-needed breathing room.
Save it for later
Perhaps that profit would make a hefty contribution to your retirement plan or a child’s college fund. Financial experts say it’s also worthwhile to put a portion in an emergency savings account to cover necessary expenses should the unexpected arise.
Regardless of how you plan to spend your windfall, talk with your real estate agent about reviewing an estimated closing cost sheet beforehand so there are no surprises.
“We always want the seller to be informed at every step of the process,” Freeman says. “If an agent is doing their job … they know pretty closely what they’re going to walk away with.”
Header Image Source: (Celyn Kang / Unsplash)