Q&A: Capital gains taxes on a house sale

Dear Liz: We purchased our home for $220,000 in 1986 and are selling it for $1 million. We own it free and clear. The proceeds from the sale will be going toward the purchase of another property, to be owner-occupied, for $1.4 million. We will be coming in with additional cash to cover the difference. Our question is whether we will be subject to capital gains tax on the proceeds from the sale of our current home.

Answer: Most likely the answer is yes.

Each owner can exclude up to $250,000 of gain from the sale of their primary residence as long as they owned and lived in the home at least two of the previous five years. Whether they have a mortgage and what they do with the money afterward isn’t relevant for calculating this tax.

You may be able to reduce the capital gains tax bill if you paid for home improvements over the years and kept good records. According to the IRS, improvements or additions that “add to the value of your home, prolong its useful life, or adapt it to new uses” can be added to your tax basis, which is usually the amount you spent to buy the home. IRS Publication 523, Selling Your Home, has details.