Ask Liz Weston

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capital gains tax

Q&A: Sale of last home can trigger capital gains taxes

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Dear Liz: I am 74 and my husband is 68. We have decided to sell our last home and rent. Do we have to pay taxes, specifically capital gains, on the sale of our last home or are we able to keep the sale proceeds in full?

Answer: Any home sale is potentially subject to capital gains taxes. Your gain is determined by subtracting your tax basis — the price you paid for the home, plus any qualifying improvements — from the net sales proceeds. If you owned and lived in the home as your primary residence for at least two of the previous five years, you can exclude up to $250,000 (or $500,000 if married filing jointly) of home sale profits. You would owe taxes on the capital gains that exceed those limits.

A large-enough capital gain could affect how much you pay for Medicare. The “income-related adjustment amount,” or IRMAA, is based on your income two years prior, so a big gain in 2025 could increase your premiums in 2027.

You’d be smart to talk to a tax pro before you sell so you understand the ramifications.

Q&A: More on those lost home improvement receipts

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Dear Liz: You recently answered a question from a home seller who had lost documentation about improvements. The improvements most likely required building permits, which would have indicated the scope of improvements and, possibly, the cost as well. The local building department will have copies of those permits on file, and they can be obtained at a modest cost.

Answer: Thank you. The original letter writer had lost their documents in a house fire, a circumstance now shared by far too many in the Los Angeles area, thanks to the recent wildfires.

To recap, the value of qualifying home improvements can reduce the taxable gain when a house is sold. But if audited, sellers probably would need some kind of proof the work was done.

Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting, suggested asking any contractors that were hired to provide verification of the projects and to check with the property tax assessor to see if the improvements were reflected in the home’s assessment. Photos of the home reflecting the improvements could also help in an audit, Luscombe says.

Q&A: Elderly and cash-strapped, a couple consider a proposal to sell their home to neighbors

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Dear Liz: I’m 80 years old and my wife is 76. Our only retirement income is Social Security, and we have less than $50,000 in savings. We have about $600,000 equity in our house, which we bought in 1971. We presently have property taxes deferred, at 6% interest. The house is in disrepair.

We have two neighbors who are willing to buy the house after one or both of us die. The neighbors are willing to postpone occupancy and contribute to mutually agreed-upon home repair costs, which will be deducted from the selling price. Details will all be in the contract. These payments will greatly improve our lives. What could go wrong?

Answer: Well, a lot, which is why you need an experienced real estate attorney to represent you if you go ahead.

It’s not clear from your letter if your neighbors are locking in a sale price now, which would mean you and your wife (or your estates) would give up future price appreciation. Are the payments simply contributions toward the repairs or are they purchase payments? Also, what happens if you need to tap your equity to pay for long-term care? If you or your neighbors want out of the deal, would that be possible? Those and many more details need to be thought through.

But your situation, and your proposed solution, are not that unusual, says Los Angeles estate planning attorney Burton Mitchell. Many older people with highly appreciated properties don’t want to sell their homes and trigger taxable gains in excess of the $250,000-per-owner home sale exclusion.

Another alternative to consider is a reverse mortgage, which could allow you to tap your equity while you remain in the home. You wouldn’t have to make payments on this loan, and the balance would not be due until you and your wife die, sell the home or move out.

Q&A: Homeownership can be a joy. It’s also full of complicated financial decisions

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Dear Liz: We replaced our original, fire-vulnerable cedar shake roof with 40-year asphalt shingles 17 years ago. I know that home improvements are added to the basis for capital gains calculation when selling the home. But when we get ready to sell the home in a few years, should the actual cost on the project be used? Or, since it was several years ago, should we calculate what a “present value” of the 2007 dollar amount would be? For that matter, should the purchase price of the home be updated to a present value?

Answer: You don’t have to discount the costs of home improvements, but you also don’t get to boost your tax basis to reflect your home’s appreciation.

To review: Your tax basis is the amount you paid for your home, plus the cost of qualifying capital improvements — projects that added to the value of your home, extended its useful life or adapted it to new uses. The tax basis is subtracted from home sale proceeds to determine the potentially taxable capital gain. If you’ve lived and owned a home for at least two of the five years before the sale, you can exempt $250,000 of home sale profits per owner.

Keeping good records of your improvements has become increasingly important over the years, because that exemption amount hasn’t been updated since it was established in 1997. Back then, the median home sale price was less than $150,000 and most home sellers didn’t have to worry about capital gains taxes. Today, the median sales price nationally is over $400,000 and there are hundreds of cities where the typical home is worth $1 million or more, according to real estate site Zillow. That means more sellers are facing capital gains that could be reduced if they have the paperwork to prove they made qualifying improvements.

You can’t include the cost of maintenance or repairs, such as painting, patching or replacing broken hardware. If the repair is part of a bigger project, though, it may qualify as a capital improvement. Replacing a broken window pane is considered a repair, for example, but replacing the whole window is a capital improvement.

You also can’t include in your cost basis any improvement that was subsequently removed or redone. If you’d replaced your roof previously, for example, you couldn’t include that earlier expense when calculating your basis.

Q&A: He’s held stocks for decades. Should he sell before he dies?

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Dear Liz: My father-in-law, age 100, has more than $1 million in stocks and bonds purchased in the 1980s and 1990s. With the stock market so high, I have suggested that he might want to sell the investments, take the tax hit and consolidate into short-term certificates of deposit or similar. This would make it easier for his family to manage (in trust) upon his death. Does this make sense or do we leave it alone?

Answer: Selling now means your father-in-law would have to pay a substantial and perhaps unnecessary tax bill on the gains he’s incurred over the years. If he instead leaves those assets to his heirs at his death, most likely no tax would be owed on the gains.

There are some exceptions, such as if the investments are held in retirement accounts or an irrevocable trust. But investments held in revocable trusts, such as living trusts, should qualify for the favorable step-up in basis that would eliminate the taxable capital gain at his death.

Yes, there’s always a risk that the markets could drop — but they would have to drop pretty far to wipe out all his gains, assuming he’s got a reasonably diversified portfolio. A fee-only, fiduciary financial planner could review the portfolio and offer recommendations about any changes that might be needed, while a tax pro could discuss potential strategies for minimizing the tax bill.

Q&A: When an inherited house gets sold, it pays to know the tax rules

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Dear Liz: My sister and I inherited a house from our mom in 2003. Back then, it was appraised at close to $500,000. It’s now worth $1.3 million and we want to sell and split the profits. My sister has lived in the house since Mom passed. Approximately what would the tax liability be?

Answer: You’ll determine the potentially taxable profit by subtracting the tax basis — the amount the house was appraised for at your mother’s death, plus any qualifying improvements — from the sale proceeds. Your sister can exempt $250,000 of her share of the profits, since she has owned and lived in the house for two of the previous five years. If her share of the profit was $400,000, for example, she would owe long-term capital gains taxes on $150,000 of that.

As a non-occupant, you wouldn’t have the option to exempt any of the profit, so you would owe long-term capital gains taxes on your entire $400,000 share. Long-term capital gains rates depend on your income, but the federal rate is 15% for most.