As a top San Francisco real estate agent, I know that your home is often one of your most valuable assets and it's important to me that you know how to maximize the return on your investment. One way to protect your investment is to make sure you understand how property taxes, especially capital gains taxes, affect you. Caveat: I am not a tax or legal advisor. Be sure to consult a qualified tax or legal representative about your situation.
If you purchased a home in San Francisco and held onto it for a few years, the chances are pretty good that your sales price will exceed your original purchase price. Clearly, this is great news. You've had a lovely home to call your own, shelter, forced savings, tax advantages and even some profit when you sell.
While profit on the sale of your primary residence is a good thing, tax liability can take a big, sometimes unexpected, bite. Many sellers are not aware of these tax liabilities. Making $100,000s over your asking price may make you feel like Richie Rich, but you may want to read this before you uncork the Champagne. (Though I highly recommend Champagne on pretty much all occasions.)
The Tax Reform Act of 1997 included a provision that single sellers can exclude capital gains of up to $250,000 on the sale of their primary residence and couples filing together can exclude up to $500,000. To qualify, people have to have lived in the home for at least two out of the past 5 years as their primary residence.
The capital gains provision for the sale of homes is an incentive for people to become homeowners. Typically, this provision is a nice bonus for people who live in areas in which the prices of homes show steady increases over time.
In the Bay Area, and in San Francisco especially, many home seller's gains will exceed the IRS's exclusion. Single owners in San Francisco are particularly affected, since it's estimated that over 25% of all homes in San Francisco currently have gains exceeding $250,000. According to Zillow, it's estimated that in the next ten years, San Francisco will see just over 77% of single owners exceeding the $250,000 limit and just under 38% of couples exceeding the $500,000 limit.
In a city that offers multiple living arrangements, this is a good question to ask. The answer is that the capital gains tax does not just apply to the sales of single family homes. Condominiums, flats, TICs, cooperatives, and even house boats can qualify as a primary residence.
In a recent New York Times article, House Value Jumping? Save Your Home Improvement Receipts, the question of how to minimize taxes when your gain exceeds your exclusion was posed with helpful suggestions about saving receipts and keeping track of home improvements. Home improvement costs can be deducted from your gain which then lowers your tax liability. In other words, go ahead and remodel that bathroom if you want to bc not only will you enjoy it more, it will also increase your home's value and lower your tax bill. Cool beans, right?
There are two ways to get ahead of the capital gains tax so that you end up saving taxes when you sell your home. For new homeowners, the first step is to start keeping records of any improvements immediately. If you already own your home and are in the process of selling, and you haven't done so already, it's time to roll up your sleeves and dig back through old records.
I consulted my CPA, Patrick Duffy, and found out how he advises his clients to keep track of their allowable expenses. Here's what Patrick has to say:
"After I explain the tax ramifications of the potential sale and taxability of the gain, I strongly advise the client to simply get a three ring binder and some lined paper like we used to use in school, then every time that there is work on the home they can describe the work and simply tape or staple the receipt to the binder.
"Now, I know this may sound old fashioned, but it is simple and it works. Also, these days, with cameras on every phone and printers in every house, before and after pictures are fantastic.
"If you happen to be a homeowner who does not have these records, but you have photos of your home taken through the time that you have owned it, you should start scanning through these photos to jog your memory of what has been done and start assembling the backup to support the improvements you want to claim. Call your credit card company if you have the old statements.
"And remember – you need to keep this proof for 7 years after you sell the home."
Excellent! Thanks Patrick. Looks like I'll be making a trip to Office Max for my own binder. 😉
The IRS has a list of approved items that can count as costs against your gains. You'll need records of these, so don't get so caught up in the excitement of buying or selling your home that you miss important deductibles. That new hot tub you bought isn't just a luxury item; it can reduce the amount of your capital gains tax.
Approved costs include new additions such as patios, bathroom and kitchen remodeling, and pools. There are even smaller items that count, such as the installation of additional fixtures and electrical outlets.
Remember: repairs do not apply. Anything that is part of regular home maintenance, such as painting a room, will not qualify unless you can show that it was part of a remodel. It may pay off in the long run to remodel a room rather than make small, incremental improvements.
Condominium owners and people who have homeowners' association (HOA) fees have other costs they can use against their gains. These include monthly fees and money that is paid into reserves funds. Just keep in mind that you will need to have receipts for these expenses in order for them to count.
It would be easy to see the capital gains tax as something negative, but look on the bright side--if you owe taxes, it means you made some good money!
Want to know whether the capital gains tax and other taxes will affect your home sale, ie. what is your home worth in today's market? Want to know how to maximize the return on your investment in your home? I can help! Let's talk.
-DL
