What to Know About Capital Gains for Luxury Homes

Luxury home sales can often exceed everyone's expectations, especially if the property is located in a high-demand area. The rules of bidding wars are radically different when it comes to wealthy buyers, which can make the appreciation of a home's value go through the roof. Capital gains for home sales are not the same as capital gains for stocks or other common assets, and sellers should understand the rules, whether selling in a community like Tuhaye or Red Ledges, long before they ever put up a for-sale sign.

Understanding Appreciation

Any asset that sells for more than it's worth is classified as a capital gain. However, it's not as simple as comparing the purchase price to the sale price. If a seller buys a luxury home for $750,000 and then sells it for $1 million five years down the road, that doesn't mean that their capital gains are $250,000. Sellers are allowed to adjust the prices to include most of the seller's fees, including the closing costs, as well as home improvements made to the home that increase the value of the property. (Standard maintenance and upkeep do not apply to capital gains deduction.) Whether this is done by adding the fees to the purchase price (e.g., original closing costs) or deducting the fees (e.g., real estate, title, and closing fees) from the seller's price, the fees will decrease the $250,000 total.

Taxation on Capital Gains

Capital gains are usually taxed at 15 percent for most homeowners. The rate of taxation is based on the seller's income and can reach as high as 20 percent for the upper brackets. Capital gains may push certain people from one tax bracket into the next, depending on the total amount of appreciation. Home sales that have depreciated in value for any reason (including due to home renovation) are not taxed. However, there are certain scenarios where capital gains tax does not have to be paid.

How to Waive Capital Gains Tax

The US government relaxed the taxes on capital gains so owners did not feel they needed to stay in one place. Currently, each owner of the home is allowed to waive up to $250,000 of capital gains if they meet certain criteria. The seller must have lived in the residence for at least two years and they are required to sell it within five years of purchase. Owners do not have to have lived in their home for two consecutive years though. So, if a homeowner lives in a home for two years and rents it out for two years, they can still waive the capital gains tax. This exemption cannot be invoked if a person has applied for the benefit in the past two years of the sale date.

Additional Exceptions

The rules for capital gains offer a number of exceptions to luxury home sellers, depending on their circumstances. For example, sellers may be able to apply for a capital gains tax waiver if they've lived in the home for less than two years but they've had a qualifying life-changing event (e.g., divorce, death of a spouse, etc.) A 1031 exchange is another way to defer capital gains taxes. While it's often used for investment properties, it can be used in the case of a standard home sale as well. In this case, a seller would buy a home that was similarly priced to their recent home sale. So essentially, there are no capital gains because the seller chooses to put the appreciation value back into another property.