Capital Gain TAX Explosion
Over the past decade, many homeowners in the U.S. have witnessed a substantial increase in their net worth due to skyrocketing residential property values. However, this financial gain may lead to significant tax implications, particularly for older homeowners.
CAPITAL GAINS TAX Explosion. Homeowners typically don't anticipate a capital gains tax when selling their homes because there is an exclusion for primary residences under specific conditions. Unfortunately, this exclusion hasn't adjusted with the rise in home values, remaining at $250,000 ($500,000 for married couples filing jointly) for nearly three decades. A recent legislative attempt—the More Homes On the Market Act—to double the exclusion amount did not pass. Homeowners who bought their homes more than ten years ago or those in areas with high property values could realize capital gains exceeding $250,000 or $500,000 upon sale, even for modest residences. This could result in unexpected and hefty tax liabilities. Here are six strategies for homeowners facing this issue:
Sell underperforming investments in the same year as the home sale. Many stock investors utilize tax-loss harvesting—selling depreciated shares to offset gains from profitable investments and thereby reduce their capital gains tax. This same strategy can offset capital gains from home sales.
Calculate capital improvement expenses. Determining the capital gain from a home sale isn’t as straightforward as subtracting the purchase price from the sale price; homeowners can add amounts spent on home improvements to the property's basis, potentially reducing taxable gains. Many homeowners might not have tracked these expenses, but they can often be reconstructed by reviewing old records. It's important to note that maintenance and repair costs don’t qualify as capital improvements.
Bequeath the property to heirs. If homeowners opt not to sell and instead leave their homes to heirs, they won't incur capital gains taxes, and the heirs likely won’t either, as they generally receive a step-up in basis. This means that they will only be taxed on the gains that occur after the original owner's death. However, this option may not work for those needing cash for retirement or to buy a new property.
Consider an installment sale. This allows the buyer to pay for the home over several years. While it doesn't diminish the overall taxable capital gain, it spreads that gain out over time, making taxes more manageable. There is a risk that buyers may default on their payments, which can complicate the process and involve additional tax calculations.
Establish a charitable remainder trust. This arrangement allows a trust to sell the home while providing the former homeowner with an income for life. The remaining assets in the trust after the homeowner's death go to a charity. This method presents several tax advantages: no capital gains tax at the sale, a tax deduction for the charitable contribution, and elimination of estate taxes for heirs. However, heirs won’t receive the home or proceeds from its sale.
Sell within two years of being widowed. Although the exclusion for single homeowners is usually capped at $250,000, widows and widowers can qualify for the full $500,000 exclusion if they sell their home within two years of their spouse’s death and are not remarried. Note that the capital gains tax exclusion applies solely to primary residences.
PROPERTY TAX EXPLOSION Another consequence of rising home values is escalating property tax bills, which are based on property value assessments. When home values surge, so do property tax bills—often at a faster rate than property values, as local governments raise tax rates to meet budget demands. This can be particularly challenging for older homeowners living on fixed incomes. While reducing property tax bills without selling and relocating can be difficult, there are some options available:
Appeal the property tax assessment. If your local government has overvalued your home, you can appeal for a reduction. Assessors often base property evaluations on outdated information, so reviewing the data on record might reveal inaccuracies that inflate your home's value. Make sure to check that any discovered errors don’t actually underrate your home’s worth.
Investigate property tax relief programs for seniors. Certain states offer programs that allow older homeowners to defer property tax payments until the home is sold or the owner passes away. These programs typically have age and income restrictions. While these deferments only delay tax payments and may incur interest, they can be useful for seniors needing immediate relief. Contact your local assessor's office to inquire about available programs.
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