Planning Ahead to Reduce Capital Gains Taxes When Selling Your Home

Homeowners who sell their home at a profit may face capital gains taxes, but with strategic planning, many homeowners can reduce or even eliminate the tax.  As property values continue to rise, more homeowners are tempted to take advantage of the increase in their home’s worth and have chosen to sell their home.

This article outlines the rules, limits, and tax-saving strategies to consider before selling a primary residence.

Understanding the Capital Gains Exclusion

Homeowners may be eligible to exclude a portion of the gain from the sale of a primary residence:

• Up to $250,000 for single filers
• Up to $500,000 for married couples filing jointly

To qualify, sellers must:

• Have owned and used the home as their primary residence for at least two of the last five years
• Not have claimed the exclusion on another home sale within the past two years

Surviving spouses may still claim the $500,000 exclusion if they sell within two years of their spouse’s death.

Due to strong market appreciation in many areas, a growing number of sellers—especially in high-value markets—may exceed these thresholds.

Adjusted Basis and Taxable Gain

The formula for calculating the gain on the sale of a home is subtracting the adjusted basis from the sales price. The adjusted basis of a home is calculated by adding capital improvements and certain closing costs to the original purchase price. Examples of capital improvements include:

• Renovations
• Roof replacements
• Room additions
• Remodeled kitchens and bathrooms

Accurate calculation of your basis is essential to minimizing taxable gain. Sellers should gather records, including:

• Receipts for improvements
• Closing statements
• Invoices related to qualifying upgrades

State Taxes Still Apply

Even if you qualify for the full federal exclusion, state-level capital gains taxes may still apply. Tax rules vary by state:

• States like Florida have no income tax
• Others, such as New York and California, typically tax capital gains at ordinary income rates—which can exceed 10%, depending on income

This underscores the importance of factoring in state tax implications as part of your overall plan.

Tax Strategies to Explore

If your gains exceed the federal exclusion, these strategies may help reduce or defer the tax burden:

Tax-Loss Harvesting

• Offset capital gains by creating capital losses in the same year that you are selling your home. If you have investments in taxable accounts that have unrealized losses, it might be a good idea to bite the bullet and sell the asset to create a realized loss.

Installment Sale

• Spread gain over multiple tax years by structuring the transaction so the buyer pays in installments. This may help avoid a spike in taxable income—but comes with risk if the buyer defaults.

1031 Exchange (for Converted Rentals)

• If the home was converted to a rental, whereby the homeowner rented out the home for at least two years prior to the sale, a like-kind exchange can defer capital gains when reinvesting in another investment property.

Timing the Sale

• Make sure to hold the property for at least one year to qualify for long-term capital gains tax rates. Properties sold within one year are taxed at higher ordinary income rates.

Recordkeeping Matters

Poor documentation is one of the most common reasons sellers overpay on capital gains taxes. To ensure accuracy:

• Save receipts for all capital improvements
• Review the original settlement statement for deductible closing costs
• Confirm whether you’ve used the capital gains exclusion in the past

The more thorough your records, the more accurately you can calculate your gain and reduce what’s taxable.

Step-Up in Basis at Death Can Eliminate Capital Gains

In certain cases, capital gains may be eliminated entirely upon the death of a homeowner. When a property is inherited, its cost basis is typically “stepped up” to the fair market value as of the date of death. If the heirs sell the home at or near that new value, there may be little to no taxable gain. This step-up in basis can result in significant tax savings, making it an important consideration in estate planning.

Planning Ahead Can Reduce Your Tax Bill

Whether you’re preparing to downsize, relocate, or unlock equity, reviewing your potential capital gains exposure before listing your home is critical. Proactive tax planning may result in substantial savings and prevent surprises come tax time.

For any questions related to capital gains taxes or personal tax planning, please reach out to your LMC professional.