Holding Court: Capital Gains or Capital Pains? The Inflation Tax on Your Home.

Holding Court is a series by retired Rye City Court Judge Joe Latwin. Latwin retired from the court in December 2022 after thirteen years of service to the City.

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By Joe Latwin

While we are blessed with solid real estate values in Rye, we are punished by the actions of the federal government in Washington since it has given us inflation. Assume you bought our home in 1990 at the market price for $250,000 and you and your beloved spouse lived there since as your primary residence and now want to sell it at its current market value of 2,250,000. Say you made $250,000 in capital improvements. Nothing else has changed except for inflation. Today’s prices are 2.41 times as high as average prices since 1990. A dollar today only buys 41.413% of what it could buy in 1990. The feds will generally tax the gain as income. Of course, if you sell it for less than $250,000, the loss will not be deductible!

How much will that cost me?

First, you must figure out your gain.  To compute your gain, you start with the amount of gross proceeds from the sale and subtract selling expenses such as commissions to arrive at the amount realized. Using our numbers, you paid $250,000, made $250,000 in capital improvements (for which, of course, you have receipts), have no selling expenses, and are selling for $2,250,000. Capital improvements do not include regular maintenance but do include things such as adding a room, installing new air conditioning, renovating a kitchen, finishing a basement, putting in new landscaping or a pool, new doors and windows, duct and furnace work, built-in appliances and water heaters. If you previously claimed a tax credit or received a subsidy for putting in energy-savings improvements, you must first reduce the cost of the system by the tax credit or subsidy that you received before computing your home’s tax basis.

Next, you figure the tax basis by taking the original cost ($250k) and adding certain selling fees and closing costs ($0), and the cost of any capital improvements ($250k).  Here, the “tax basis” is $500,000.

Then, you take the sales proceeds ($2,250,000) then reduce that figure by your tax basis in the home to come up with your gain or loss.  Subtracting your basis ($500k) from the sales price ($2,250k) gives you your gain of $1,750,000.

Now, what would be the tax on that gain?

Some of the profit isn’t taxed. There is a home sale exclusion. If you have owned and lived in your main home for at least two out of the five years before the sale date, up to $250,000 ($500,000 for joint filers) of your gain is tax-free. We assumed you and our beloved spouse have lived in the home for the past three years or more. Thus, any gain above the $500,000 exclusion amount is taxed at long-term capital gains rates. If you subtract the $500,000 exclusion from the $1,750,000 gain, you have $1,250,000 in taxable capital gains.

Capital gains are taxed at favorable rates of 0% (for joint filers with income up to $94,050) or 20% (for joint filer with income up to $583,751, plus a 3.8% net investment income tax for people with higher incomes). We’ll have our married couple pay a 20% tax on that, or $250,000!

There are ways to avoid this capital gains tax entirely if you want to transfer the property to your heirs. To find out how, you’ll need to hire me!