The 1997 Taxpay Relief Act allowed for a $250,000 capital gains exclusion for a single person and $500,000 for a married couple when a personal residence was sold. The caveat was that the homeowner needed to live in the home for the last two out of five years in order for the exclusion to apply. In 1997, that seemed like a lot of money.
In 1997, the average price for a home in Boulder County was about $200,000. Today the average price for a home in the county is $624,000. Within the City of Boulder, the average price is over $1 million.
The capital gains exclusion has not been increased in 24 years. When the law was enacted, it meant there would not be a capital gains tax bill for most American homeowners when they sold their homes. That might still be true in some markets, but in Boulder County and especially in the City of Boulder, home price appreciation has outpaced tax relief – and there does not appear to be an increase in tax relief on the horizon.
As a result of the huge gap between price appreciation and tax relief, it is now more important than ever for homeowners to keep an excellent record of capital expenditures spent on their homes. The reason is that capital expenditures add to the tax basis of the home, thereby reducing the final tax liability.
Here is an example of how it works. Let’s say a single person bought a home for $350,000. When that person decides to sell the home, due to price appreciation, the home sells for $700,000. $250,000 of the gain will be exempt with no taxes due, but the other $100,000 will be taxed at the long-term capital gains tax rate of 15%. The taxes in this example would be $15,000. There are other additions and subtractions to the tax basis, but they are not discussed in this example for the sake of simplicity. Your income can change the capital gains tax rate that applies to you. The 15% rate applies to income levels from $40,001 to $441,450.
Using the above example, if the homeowner applied $100,000 in documented and verifiable capital improvements to the home, the tax basis would increase from $350,000 to $450,000. The total gain would be $250,000, which is equal to the amount excluded for a single person. In this case, no capital gains taxes would be due.
Every homeowner should keep a record with receipts and photos of all home improvements to document and verify that the improvements were actually done. When it comes time to sell the home, the homeowner should meet with a tax professional and determine which items actually qualify to add to the tax basis. Some items will be considered as repairs and will not be added to the tax basis.
In general, a repair is considered to be maintenance of an existing item, such as, simple plumbing repairs, replacing a broken window, or putting Freon in an air conditioner. A capital improvement, however, would be something that adds value to the home or extends the life of the home. Examples include adding square footage to the home, replacing all windows, adding a new roof or new furnace.
There are other expenses at time of sale that could reduce the tax liability. Those could include brokerage fees, fix-up to sell expenses, and other costs of sale.
If you are thinking of selling, and your capital gain is likely to be above the $250,000 and $500,000 limits mentioned above, be sure to consult your Realtor® and a tax professional before signing a contract to sell.
By Duane Duggan. Duane has been a Realtor for RE/MAX of Boulder in Colorado since 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by
RE/MAX International: The Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail DuaneDuggan@boulderco.com, call 303.441.5611 or visit boulderco.com.