how to avoid capital gains tax when selling your Fairfax home

How to Avoid Capital Gains Tax When Selling Your Fairfax Home

Despite the costs, real estate is a phenomenal store of wealth. Your Fairfax home value has increased roughly inline with inflation – depending on your source and timing of information. Since we work so hard to protect and preserve our most valuable asset, the ability to potentially avoid capital gains tax and unlock equity when selling your Fairfax home is a beautiful thing.

Owning a home is expensive. The maintenance, repairs, improvements and refurbishments, on top of the mortgage payments and property taxes – all for the privilege of enjoying a place you can call your own. This amounts to serious negative cash flow.

Equity, Equity, Equity

The Federal Reserve estimates that total household owners equity is currently $18.7 trillion, and has increased by more than $1 trillion in the past year alone. Equity is your ownership; the difference between your Fairfax home value and the mortgage balance. It should be what you keep when selling your Fairfax home. 

Your Fairfax real estate agent might talk about location, location, location as your prime concern when looking to buy a house. But once you’ve made the best decision you can, it’s all about improving and preserving your home value and building equity as your mortgage amortizes, so painfully slowly.

The great news is that you will eventually realize equity growth, and on average it grows at an accelerated pace each moth. 

Northern Virginia Equity

The robust Northern Virgina real estate market which includes Fairfax City, and Fairfax County, has enjoyed strong growth in property values that supports the data findings of the Federal Reserve above.

The Northern Virginia Association of Realtors (NVAR) most recently reported home sale data for August 1019. Here’s an excerpt:

  • AUG. 2019 Average Sale Price (all dwellings): $609,193 - up from $457,805 in 2009
  • AUG. 2019 Average 4BD Detached Sale Price: $886,281 - up from $657,690 in 2009

On average, property owners have enjoyed an increase in value of $150,000 over the past decade in our market. Owners of four bedroom detached homes have experienced more than $225,000 growth in asset value on average over the same period. That is quite literally your sweat equity from your hard work. When combined with the reduction in mortgage balance over the corresponding period, homeowners could potentially access considerable equity.

TWO BASIC STRATEGIES

There’s two basic strategies that will maximize your tax efficiency when selling you Fairfax home. The first is to sell your property before exceeding your tax free threshold. Secondly, by increasing the cost basis by the value of all capital improvements.

There is a distinction between equity, and capital gain. Equity is difference between your home value and your mortgage balance. Capital gain is the difference between your home value and purchase price (cost). Your purchase price is considered to be the COST BASIS in your house as an asset.

1. Sell Your Fairfax Home Before Exceeding the IRS Tax Free Threshold

We don’t often get gifts from the IRS, but the Home Sale Gain Exclusion is significant and directly benefits you when selling your Fairfax home.

This rule allows up to $250,000 in capital gains to be excluded from taxable income, $500,000 if filing jointly. There is only two tests to pass when qualifying – you must own the home and have used it as your personal residence for two (2) out of the five (5) years preceding the sale. 

It is important when tax planning to understand when you are approaching your tax free threshold. Exceeding your tax free limit means that you will be required to pay income tax by that amount. This is tax inefficient.

For example: If your home sold for $800,000 and your cost basis was $250,000 – this represents $550,000 in capital gain. If filing jointly, the first $500,000 is excluded but you will have to include the remaining $50,000 as taxable gain.

A better solution is to avoid capital gains tax by selling before the threshold is passed and moving to a new residence to begin a new phase of tax free equity growth. 

2. Increasing The Cost Basis by the Value of Capital Improvements

The IRS allows homeowners to increase the cost basis of their personal residence by the value of capital improvements. That means that the cost of renovations is added to the price you paid for your home. This increase in cost basis narrows the gap between purchase price and sale price, effectively expanding your tax free threshold.

For Example: As above, your house sold for $800,000 and the cost basis was $250,000 – however the $550,000 capital gain is offset by a $100,000 addition. This increases the cost basis to $350,000 and reduces the capital gain to $450,000 – well under the joint filing threshold of $500,000.

The cost of improvements is not limited to materials, but also includes labor, contractors, architects, and permits. So no matter whether you did the improvements yourself or with the help of professional, it’s important to keep all the receipts to document your claim to the IRS.