With so many luxury properties around the city, and land in Los Angeles going for a premium, we regularly see homes sell for tens of thousands, possibly even millions, over the listing price. Demand for LA property has dramatically risen across several coveted neighborhoods. Therefore, it’s understandable that sellers would assume a high sales price easily translates to a monumental payday. However, some sellers may be in for a bit of a shock. Due to capital gains on primary residence sales, they could be walking away with less than they imagined.
How Exclusions for Capital Gains on Primary Residence Sales Work
The “primary” in primary residence is actually a pretty important distinction. Under current U.S. tax laws, homeowners may be eligible for a capital gains exclusion when selling their primary residence. Single status owners may exclude up to $250,000 of capital gains from their federal taxes, whereas married owners filing jointly may exclude up to $500,000. In most cases, the seller will need to have lived in the home as their primary residence for at least two of the five years preceding the sale in order to qualify for the exclusion.
However, in high-value markets like Los Angeles, that exclusion may not be enough to cover all of the gain. Let’s look at an example. Say a homeowner purchased a property for $600,000 but then later sells it for $1.6 million. In this case, we can assume the entirety of the gain is protected. However, after considering the original purchase price (adjusted for upgrades), any gain beyond the exclusion limits may be subject to federal capital gains tax – and possibly even California state tax, which does not offer the same exclusion.
What if the Primary Residence Became a Rental Property?
Homeowners who rented out their primary residence face further complications. Renting a primary residence doesn’t automatically disqualify a homeowner from using the exclusion, but depreciation taken during the rental period could be subject to depreciation recapture by the IRS. This amount is taxed separately and cannot be excluded, even if the home returns to a primary residence again.
Situational Awareness: Getting the Timing Just Right
Of course, timing matters a great deal when strategizing for capital gains on primary residence sales. Sellers who haven’t owned and occupied their home for at least two years may qualify for a partial exclusion, or possibly even none at all. Some situations may bring partial relief, such as job relocation, specific health problems, and other qualifying events. But some sellers are simply out of luck.
Don’t Forget the Deductions and Seller Expenses
Costs associated with selling a home can also influence the end results. Some sellers may attempt to strategize by using closing costs, agent commissions, or other selling expenses to reduce taxable gain. But this means reducing net proceeds as well. Sellers should avoid making the mistake of fixating on the gross sales price without fully considering these deductions and expenses.
The Importance of Supporting Documents
Underscoring the importance of documentation in real estate, homeowners who have owned their primary residence for a considerable amount of time may not have the necessary supporting documents for capital improvements, which can drive up the property’s cost basis while reducing taxable gain. These improvements can include room additions, major renovations, system upgrades, and the like. Lack of supporting documents can put exclusions in jeopardy.
The Benefit of a Qualified Tax Professional
It’s important to understand how capital gains on primary residence sales work, especially in markets like Los Angeles, where capital gains can be substantial. The nuances of the rules can sometimes catch sellers off guard. Therefore, consulting a qualified tax professional prior to listing a primary residence can help sellers set realistic expectations while avoiding unwelcome surprises at closing. Don’t have one in mind? Ask one of our agents for professional recommendations in your area. They’re always happy to help!
With a brand that says as much as JohnHart’s, Senior Copywriter Seth Styles never finds himself at a loss for words. Responsible for maintaining the voice of the company, he spends each day drafting marketing materials, blogs, bios, and agent resources that speak from the company’s collective mind and Hart… errr, heart.
Having spent over a decade in creative roles across a variety of industries, Seth brings with him vast experience in SEO practices, digital marketing, and all manner of professional writing with particular strength in blogging, content creation, and brand building. Gratitude, passion, and sincerity remain core tenets of his unwavering work ethic. The landscape of the industry changes daily, paralleling JohnHart’s efforts to {re}define real estate, but Seth works to maintain the company’s consistent message while offering both agents and clients a new echelon of service.
When not preserving the JohnHart essence in stirring copy, Seth puts his efforts into writing and illustrating an ongoing series entitled The Death of Romance. In addition, he adores spending quality time with his girlfriend and Romeo (his long-haired chihuahua mix), watching ‘70s and ‘80s horror movies, and reading (with a particular penchant for Victorian horror novels and authors Yukio Mishima and Bret Easton Ellis). He also occasionally records music as the vocalist and songwriter for his glam rock band, Peppermint Pumpkin.
