March 2017 // Real Estate & Home Builders Guide // 3M
How to calculate the profit on sale of a home
By Ilyce Glink
and Samuel J. Tamkin
Tribune Content Agency
Q
: Your recent article on
capital gains on the sale of
multiple homes got me thinking
about exactly how to calculate
that profit.
Is the profit the difference
between the sale price of the
house today against your current
mortgage balance, or it is the
difference between the sale
price today against the original
purchase price, adjusted for
whatever permanent modifica-
tions you made after the purchase
(adding a deck, finishing the
basement, updating the kitchen,
etc.)?
Second question: We are
inheriting my in-laws’ home
in another state. We intend to
keep the house for our exclusive
use (not as a summer rental) for
another 18 months and then move
into it as our permanent residence
for the next 10 years. How do we
determine the base value of this
property that we would use to
calculate the profit when we sell
that house?
: We’ll start with your first
question. You could buy a
home for $100,000 in cash, have
no mortgage on the property and
later sell it for $500,000 for a
profit of $400,000. Or you could
have refinanced a mortgage on
that property over the years and
have a $300,000 loan still due at
the time you close on the sale.
In our example, if there was
no mortgage on the property,
you’d end up with $400,000 in
cash (excluding all of the costs
of sale, of course); but if you
had a $300,000 mortgage on the
property, you’d only end up with
$100,000 in cash at closing. As
you can see, the amount of money
you with up with from either of
these scenarios is quite different.
In computing that profit,
you have to figure out what the
property “cost” you. Accountants
A
frequently talk about your cost
basis in a property. To calculate
the cost basis, you start with
the purchase price and add the
other costs of purchasing the
property; then you add in the
capital improvements you have
made to the property over the
years. When those improvements
are structural or mechanical
(as opposed to decorative), you
can add those in as well to your
“cost.”
When you sell the property,
you have costs associated with
the sale of the property, including
commissions, transaction fees
and other closing expenses. To
calculate the cost basis, add
the costs of purchase, capital
expenses and cost of sale
together. The total is your true
cost basis for the property.
If in our example, you had
capital expenses, purchase
costs and selling expenses of
$150,000, your cost basis would
be $250,000. So if you sell the
property for $500,000, you’d
have a $250,000 profit. You asked
about the costs of adding a deck,
finishing the basement, and
updating the kitchen. It would
seem to us all of those improve-
ments would add to the cost basis
of your home.
We’ve greatly simplified our
example for you and didn’t take
into account whether the property
was an investment property and
whether you took depreciation on
your federal income tax returns.
Depreciation gives you tax
benefits over the time you own
the property but that depreciation
affects your basis -- that is, it
reduces your basis.
We should also mention that
if you are selling your primary
residence (and have lived in
the residence for two out of the
last five years), you can exclude
from federal income taxes up
to $250,000 of profit; and if you
are married, you can exclude
from federal income taxes up to
$500,000 of profit. For the vast
majority of homeowners selling
their primary residence, they
won’t have to worry about paying
federal income taxes when they
sell their home.
On the second home you
inherited, the “cost” to you
should be the value of the
home at or around the time you
inherited the home. So if you
inherited the home and it was
worth about $250,000, that’s your
starting point. You’ll use that
home as a second home for some
time and if the tax laws stay the
same, that home will eventually
become your primary residence
and you should get the same
$250,000/$500,000 exclusion
from federal income taxes, but
you would still have to recapture
any depreciation you take when
the property is a rental.
As you own that home, be sure
to keep printed or digital records
of capital improvements you
make over time.
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