Understanding Capital Gains Tax When You Sell Your Home
Selling your home for a profit is a major financial milestone. However, that profit—known as a capital gain—can be subject to taxes. Fortunately, the tax code includes a generous exclusion for primary residences that allows most homeowners to pay zero tax on their gains.
This guide explains how capital gains tax on real estate works and how to qualify for the exclusion.
What is a Capital Gain?
A capital gain is the profit you make when you sell an asset for more than you paid for it. For your home, the basic formula is:
Selling Price – Cost Basis = Capital Gain
What is Your “Cost Basis”?
Your cost basis is not just the original purchase price of your home. It’s a calculation that includes several factors:
- The original purchase price.
- Certain closing costs you paid when you bought the home (like title fees).
- The cost of capital improvements you made to the home (e.g., a new roof, a kitchen remodel, or adding a deck).
A higher cost basis reduces your capital gain, which is why keeping good records of your improvements is so important.
The Home Sale Tax Exclusion (Section 121)
This is the most important tax rule for homeowners. If you meet the eligibility requirements, you can exclude a significant amount of your capital gain from your income, meaning you pay no tax on it.
- For single filers: You can exclude up to $250,000 of profit.
- For married couples filing jointly: You can exclude up to $500,000 of profit.
How to Qualify for the Exclusion
To be eligible for the exclusion, you must meet two main tests:
- The Ownership Test: You must have owned the home for at least two of the five years leading up to the sale.
- The Use Test: You must have lived in the home as your primary residence for at least two of the five years leading up to the sale. (The two years do not have to be continuous).
You can generally only use this exclusion once every two years.
How Domidocs Helps You Maximize Your Tax Exclusion
Accurately calculating your cost basis is the key to minimizing your capital gains tax, and that requires meticulous record-keeping. Domidocs is the perfect tool for this.
1. A Permanent Record of All Improvements
The Domidocs secure digital vault is the ideal place to store every receipt and contractor invoice for all the capital improvements you make to your home. When you add a new deck, remodel a bathroom, or replace the windows, you can instantly scan and upload the receipts. Over the years, this creates a complete and organized financial history of your investment.
2. Simplify Your Tax Calculation
When it comes time to sell, you won’t have to hunt through a decade of old files. All the documentation you need to accurately calculate your cost basis is already organized in your Domidocs account. This simple process can save you thousands or even tens of thousands of dollars in taxes by ensuring you don’t overstate your capital gain.
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