Ask Liz Weston

Get smart with your money

capital gains taxes

Q&A: How to finance a remodeling project

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Dear Liz: I am doing a small remodeling job to my home that will cost $80,000. I have enough in my investments to withdraw the $80,000. Is it better, tax wise, to get a home equity loan to pay for it?

Answer: Like so many tax questions, the answer depends on your circumstances. How your investments would be taxed depends in part on what account they’re in. Withdrawals from most retirement accounts are taxed as income, and can incur penalties if you take the money out too early.

Withdrawals from regular brokerage accounts also can be taxed as income if you’ve held the investments less than one year. If the investments have been held for more than one year, you can qualify for more beneficial capital gains tax rates. The amount of tax you would pay depends on how much the investments appreciated in value since you bought them as well as your income tax bracket. Most people pay a federal capital gains rate of 15%, although lower income taxpayers can qualify for a 0% rate while higher earners pay 20%.

You may have the opportunity to engage in what’s known as “tax loss harvesting.” That means selling investments that have lost value since you bought them, and using that loss to offset the gains on other investments you’ve sold.

Interest on home equity borrowing, meanwhile, may be deductible if the proceeds are used to improve your home and the combined total of your mortgage debt doesn’t exceed $750,000 for a married couple filing jointly or $375,000 for singles.

To deduct the interest, though, you must itemize your deductions. The vast majority of taxpayers now take the standard deduction of $31,500 for married couples or $15,750 for singles. People 65 and older can take an additional $1,600 per qualifying spouse or $2,000 if single. In addition, people 65 and over can take an additional $6,000 bonus deduction if their income is under certain limits. The bonus begins to phase out for single filers with modified adjusted gross income over $75,000, and for joint filers over $150,000.

That’s the long answer. The shorter answer is that the taxes you’ll pay cashing in your investments are likely to be less, and perhaps significantly less, than the interest you’d pay on the loan. But you’ll need to do your own math, or ask a tax pro for help.

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: When receipts of home renovations are lost, is the tax break gone too?

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Dear Liz: I have sold my family home recently after almost 50 years. I had done lots of improvements throughout those years. Due to a fire 15 years ago, all the documentation for these improvements has been destroyed. How do I document the improvements for the capital gains tax calculation?

Answer: As you probably know, you can exclude $250,000 of capital gains from the sale of a principal residence as long as you own and live in the home at least two of the previous five years. The exclusion is $500,000 for a couple.

Once upon a time, that meant few homeowners had to worry about capital gains taxes on the sale of their home. But the exclusion amounts haven’t changed since they were created in 1997, even as home values have soared. Qualifying home improvements can be used to increase your tax basis in the home and thus decrease your tax bill, but the IRS probably will demand proof of those changes should you be audited.

You could ask any contractors you used who are still in business if they will provide written verification of the work they performed, suggests Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. You also could check your home’s history with your property tax assessor to see if its assessment was adjusted to reflect any of the improvements.

At a minimum, prepare a list from memory of the improvements you made, including the year and the approximate cost. If you don’t have pictures of the house reflecting the changes, perhaps friends and relatives might. This won’t be the best evidence, Luscombe concedes, but it might get the IRS to accept at least some increase in your tax basis.

If you’re a widow or widower, there’s another tax break you should know about. At least part of your home would have gotten a step-up in tax basis if you were married and your co-owner spouse died. In most states, the half owned by the deceased spouse would get a new tax basis reflecting the home’s current market value. In community property states such as California, both halves of the house get this step-up. A tax pro can provide more details.

Other homeowners should take note of the importance of keeping good digital records. While documents may not be lost in a fire, they may be misplaced, accidentally discarded or (in the case of receipts) so faded they’re illegible. To make sure documents are available when you need them, consider scanning or taking photographs of your records and keeping multiple copies, such as one set in your computer and another in a secure cloud account.

Q&A: Clearing up some confusion over those proprietary funds

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Dear Liz: Your recent column about proprietary funds confused me. You mentioned that selling these funds can trigger capital gains tax. Is it not true we can move investments directly from one money manager to another and not take a capital gain as long as the funds remain invested?

Answer: If you can move a fund from one investment company to another, then it likely is not a proprietary fund. For example, Schwab, Fidelity, Vanguard and many other firms create funds that bear their names, but these investments can be bought and sold at other brokerages.

Proprietary funds, by contrast, typically lock customers into investments that can’t be transferred to another firm. To get your money out, you have to sell the fund, which can trigger a tax bill. This is a significant downside and one investors should understand before committing their money to this type of fund.

Q&A: Closing the case on the couple moving into their rental property

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Dear Liz: You recently answered a question from a couple who wanted to move into their rental property, make it their primary residence and use the $500,000 home sale exclusion if they sold the property after living there for two years. You should have made it clearer that not all of the gains on the property would qualify for the exclusion.

Answer: Quite right. In 2008, Congress closed the loophole that allowed people to exclude all the gains when they turn rental property into their primary residence. So the couple would not be able to count the gain that occurred between 2009 and whenever they move in. They would, however, be allowed to include the gain from 1988, when they bought the property, through 2008, as well as any increase in value after they move in if they live in the house at least two years, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

In some parts of the country, there may not be enough gains from those two periods to qualify for the full $250,000-per-owner exclusion, especially after accounting for the depreciation recapture, which requires landlords to pay back the depreciation tax break when they sell a rental property.

In higher-cost areas, however, there still could be more than $500,000 of qualifying gains, Luscombe says.

Q&A: I need new wheels. What’s the best way to pay for them?

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Dear Liz: Is it better to buy a car with saved money or finance the $25,000 needed? In my case I will have to sell stocks. Maybe this is a good time to do that since things look like they are taking a turn in the stock market.

Answer: Borrowing money can make sense when the asset you’re buying is likely to increase in value. For example, a mortgage could allow you to purchase a home that will appreciate over time, and a student loan could help increase your earning power.

Borrowing money makes less sense when you’re buying something that’s all but guaranteed to lose value, such as a car. Many people don’t have enough cash to pay for a reliable vehicle, of course, so financing is their best option. If you do have a choice, however, cash is best.

Selling stocks can help you raise cash, of course, but probably will incur a tax bill. Also, stocks are meant to be a long-term investment, and you really can’t time the market. Yes, your shares may decline, but they could also rise, and historically they have done so over time.

If you don’t have cash savings but do have stocks that aren’t earmarked for another cause, such as retirement, then you might consider selling enough stocks to pay for the car and the tax bill. For your next car, though, consider saving up for the purchase in a high-yield savings account.