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I'll Net $675K From Downsizing My Home. What Can I Do to Avoid Capital Gains Tax?

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It’s often said that buying a house is one of the best investments you can make. And, just like any investment, it comes with tax issues.

With an investment like stocks or bonds, the profit you make when you sell your holdings – minus the initial investment and any expenses that comprise your tax basis  – is subject to tax. If you buy and sell an investment in 12 months or less, your profit is taxed as ordinary gains, just like all your other taxable income. If you hold the investment for more than a year, you get a break and your profit is considered capital gains, which are taxed at a lower rate of  0%, 15% or 20%, depending on your other income. But some options exist for homeowners to help them reduce or, in some cases, avoid capital gains taxes entirely.

A financial advisor can help you establish a plan to manage taxes associated with real estate. Get matched with a financial advisor today.

There’s an additional break when you profit from the sale of a house. If the property has been your principal residence for two of the last five years, you get a one-time exemption that allows you to exclude $250,000 of the profits from tax if you’re a single filer, or $500,000 if you’re a joint filer. To qualify, you also can’t have used this exclusion in the last two years, although there are some exceptions, as the IRS outlines here, including moving for work- or health-related reasons.

If you’re a single filer, this means only $425,000 of your profit is taxable. But that’s just the beginning.

Besides your initial purchase price, the tax basis of your home can include some improvements and other related costs, including abstract title fees, transfer or stamp taxes, owner’s title insurance and other sales-related charges. You also can include improvements made to the home, such as adding a deck, upgrading windows, modernizing a kitchen or bathroom and others. Repairs don’t count, but items needing repair that are part of an improvement do count. If you get a tax break for an improvement, such as an energy tax credit, you need to deduct that from the total cost.

If you made $50,000 worth of improvements to the house and paid various selling costs of $5,000, you’ve now knocked the taxable gain down to $375,000. And you’re not even done yet.

A financial advisor can help you determine which costs associated with your home contribute to your basis and therefore reduce your taxable gains. Talk to a financial advisor today.

If you have capital losses in some other investment, such as stocks, you can use those losses to offset the gains on your home. However, you can offset long-term gains with long-term losses only, and short-term gains with short-term losses.

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