Understanding the Financial Basics of Selling Your Home
Before you place a “For Sale” sign in your yard, it is crucial to understand the key financial concepts that will impact your bottom line. Knowing these rules can save you thousands of dollars and prevent unexpected surprises down the road.
Capital Gains and the Home Sale Exclusion
The most important financial topic to understand is capital gains tax. A capital gain is the profit you make from selling an asset, in this case, your home. It is calculated by taking the sale price and subtracting your “basis.” Your basis is typically the original purchase price plus the cost of any major capital improvements you made over the years (like a new roof or a kitchen remodel, not routine maintenance).
Example: You bought your home for $80,000 thirty years ago. Over the years, you spent $20,000 on a new addition. Your basis is $100,000 ($80,000 + $20,000). If you sell the home for $450,000, your capital gain is $350,000 ($450,000 – $100,000).
Fortunately, the government provides a generous tax break for homeowners. It is called the Home Sale Exclusion. This rule allows you to exclude a significant portion of your capital gain from taxes, provided you meet certain criteria. The two main requirements are:
1. Ownership Test: You must have owned the home for at least two of the five years leading up to the sale.
2. Use Test: You must have lived in the home as your primary residence for at least two of the five years leading up to the sale.
If you meet these tests, the exclusion amounts are:
- $250,000 for a single filer.
- $500,000 for a married couple filing a joint tax return.
Let’s apply this to our example. If you are a single filer with a $350,000 gain, you can exclude the first $250,000. You would only owe capital gains tax on the remaining $100,000. If you are a married couple filing jointly, you can exclude up to $500,000. In that case, your entire $350,000 gain would be tax-free. This exclusion is a powerful tool for seniors selling a long-term residence. For more detailed information on your specific tax situation, the best source is always the IRS.
Calculating Your Net Proceeds
The price your home sells for is not the amount of money you will walk away with. It is essential to estimate your net proceeds to plan your next steps, whether that is buying a smaller home, moving into a senior housing community, or investing the funds. To calculate your net proceeds, start with the sale price and subtract the following:
- Real Estate Commissions: Typically 5-6% of the sale price, split between the buyer’s and seller’s agents.
- Closing Costs: These can include transfer taxes, attorney fees, and other administrative costs, often totaling 1-3% of the sale price.
- Remaining Mortgage Balance: You must pay off any outstanding mortgage on the property.
- Staging and Repair Costs: The money you spent preparing the home for sale.
Example: On a $450,000 sale, you might have $27,000 in commissions (6%), $9,000 in closing costs (2%), and a $50,000 remaining mortgage. Your estimated net proceeds would be $364,000 ($450,000 – $27,000 – $9,000 – $50,000), before accounting for any repair costs.
