One of the most common mediation subjects revolves around selling homes. To sell or not to sell is certainly a crucial and frequently difficult decision. Yet few preface their decision-making with an analysis of the financial implications inherent in the question. The emotional components take center stage—attachment to home and all of its memories, not to overlook consideration of stability and consistency for family members. Yet, despite the personal impact of change on all involved parties, the discussion needs to be more expansive; it needs to include the monetary impact of the sale.
Let’s take a closer look at the financial side of any discussion involving a potential sale of a home, starting with the primary residence.
1. Federal Tax Implications:
Hopefully, you have kept records of improvements you made to your home. Capital improvements are believed to “increase the value of your home, prolong its useful life or adapt the property to new uses,” such as creating a rental unit, and they, in and of themselves, reduce the taxes you will pay upon sale of the property.
Take a walk through your home, going into each room as well as outside, and record changes that you made during your ownership. Consider the following list:
In addition, legal fees relating to the capital improvements count toward reducing taxes, as well as real estate commissions and closing costs. What does not count are the repairs or basic upkeep, such as painting the interior or exterior of the house, fixing and maintaining gutters, repairing leaks and the like or your labor in executing the renovations. If you did the work by yourself, the only tax-deductible components are the materials purchased.
2. Once you have completed your list of capital gains improvements and calculated the cost of each item, then you are ready to project the federal tax implications of a sale:
Cost of home when purchased (e.g., $400,000)
Cost of capital improvements (e.g., $200,000)
Basis of house is now: $600,000
If you and your spouse have owned and used the house as your principal residence for the two out of the last 5 years, you each are entitled to $250,000 capital gains exclusion. As such there is another $500,000 to add to the basis of the house, bringing the sale price up to $1,100,000 before you incur capital gains taxes upon sale. In addition, the real estate commission gets added to the total, raising the sale price allowance even higher before any federal tax impact.
If there is only one owner of the principal residence, then the tax exclusion is $250,000. Using our example above, the basis for a single-owner sale would be $850,000.
Remember that this exercise pertains solely to the sale of homes that are principal residences. If, for example, you are selling a vacation home, using the same purchase price and same capital improvements, $600,000 is the basis to be used when projecting the impact of capital gains. Obviously, or not so obviously, there are other considerations, such as if the house was rented or there were tax depreciations taken. The latter analysis requires expert input that is beyond the scope of this article.
Mediation provides a confidential and safe environment to discuss both the emotional and financial aspects of the sale of a home. Although we have concentrated only on the impact of federal tax consequences, financial ramifications are far more extensive, including, but not limited to, liability for state taxes, the distribution of net sale proceeds, and the individual usage of moneys received. Under the guidance of a knowledgeable and skilled mediator, participants are encouraged to voice their concerns and focus on their priorities at the same time that they analyze the implications of their decision-making on all parties.
