Single sellers can exclude $250,000 from their taxable profit and married sellers $500,000. The amounts haven’t changed in 25 years.

It has been a seller’s market for houses in recent years, particularly in the pandemic. But bigger profits for homeowners may, in some cases, mean a large tax bill.

For decades, most Americans have been shielded from paying capital gains taxes on the sale of their homes unless their profits exceeded certain limits. But the surge in housing values means that more homeowners could see taxable windfalls when they sell, especially if they have owned a home for a long time, accountants say.

Whether you’ll owe tax on the sale of your main home depends on several factors, including your eligibility for the capital gains “exclusion,” an amount you can subtract from your taxable profit when you sell. The exclusion allowed by current tax law is based on your tax-filing status: $500,000 for a married couple filing a joint return and $250,000 for a single filer.

But it’s becoming easier to exceed those amounts, which haven’t changed since they were set in 1997. The typical sales price for a previously owned single-family home more than doubled in just the last decade, to $353,600 last year, according to the National Association of Realtors. As a result, the association sees a growing potential for capital gains taxes, said Evan Liddiard, a certified public accountant and director of federal tax policy for the association.

That could make some homeowners reluctant to sell, further squeezing an already tight supply of properties, Mr. Liddiard said. Evidence so far is anecdotal, he said.

The worry is particularly acute in high-priced markets on the coasts, said Greg White, an accountant in Seattle. “If you are in San Francisco, Seattle, New York or Boston,” he said, “it’s easy to go over the $500,000 limit.”

To qualify for the exclusion, you must have owned the house and lived in it as your main home (the Internal Revenue Service also calls it your “primary residence”) for at least two of the five years before the sale closes. You can have just one main home at a time, for tax purposes. It’s generally the address where you spend most of your time and that’s listed on documents like your tax return, voter registration card and driver’s license. (Some New York accountants use what’s humorously called the “teddy bear” test: If the home is where you keep your teddy bear at night, then it’s your main home.)

The two years don’t have to be consecutive; you can have had a different main home for part of the five-year period.

Here’s an example: Say you bought a house 10 years ago for $300,000 and sold it for $600,000 in 2021, for a gain of $300,000. If you are married, you would probably owe no capital gains tax because the gain is less than $500,000. If you’re single, however, you may owe tax — but just on the $50,000 that exceeds the $250,000 cap.

There are steps you can take, however, to reduce the amount of your gain that is taxable.

First, you can subtract costs associated with the sale of the house, like real estate commissions and transfer and appraisal fees.

You can also increase your “basis” — the dollar amount on which the gain is based — by adding to your purchase price the cost of any improvements made to your home over the years. The improvements must be projects that add to the value of the house and extend its useful life. Replacing the pipes in your house would qualify, but swapping out a shower head would not, said Michael Durant, a senior accountant at Prager Metis in Manhattan.

If you added a room, remodeled your kitchen or replaced a roof, all those costs can be added to your basis, which helps to shrink your gain and the associated tax, said Isabel Barrow, director of financial planning at Edelman Financial Engines, a financial planning and wealth management firm.

Ms. Barrow suggested that homeowners maintain a spreadsheet showing the date and cost of any improvements. Homeowners should save receipts, invoices and design plans to justify an increase in their property’s basis.

Here’s how it could work, continuing with the hypothetical single seller who exceeds the $250,000 cap by $50,000. Say you paid a 6 percent real estate commission ($36,000). You would subtract that from the selling price, reducing it to $564,000. Perhaps you spent $15,000 to upgrade a bathroom; you would add that to the price you paid for your home, raising your basis to $315,000. The gain would then be $249,000 ($564,000 minus $315,000), below the exclusion for a single filer — so you’d owe no tax.

Most people who have lived in a home for a long period have made significant improvements, whether it’s building a swimming pool, installing blinds or adding a generator, said Melanie Lauridsen, senior manager of I.R.S. advocacy and relations with the American Institute of Certified Public Accountants. The improvements count, she said, “even if you paid for it a long time ago.”

If you don’t qualify for the full exclusion, there are exceptions that may make you eligible for at least part of it. Say you bought a home but have to sell it within two years because of a job relocation, an illness or disability, or another unforeseen event that forces a move. You may be able to claim a partial exclusion. The I.R.S. provides a worksheet, but it’s best to get professional advice to make sure you get the details right, Ms. Barrow said.

There is also a limit on how often you can take the exclusion: only once every two years.

If you do end up with a taxable gain, the tax amount depends on your federal bracket and how long you owned the property. Long-term capital gains tax rates, which apply to assets held for at least a year, are generally lower. Short-term gains are taxed at ordinary income rates. (Some states may also charge their own capital gains taxes.)

What if you own a second home as a weekend getaway? The capital gains exclusion may apply, depending on the details of how you use the property, Ms. Lauridsen said. She cited the example of a couple who lived in Washington, D.C., and had a weekend home outside the city. The wife retired and moved to the weekend home, which the couple then declared to be their main home. (The husband stayed at the city home during the workweek and joined his wife at their new “main” home on the weekends.) When the husband retired, they sold their city home and qualified for the capital gains exclusion because it had been their main home for at least two years before the sale. Then, two years later, they sold their “new” main home (formerly the weekend home) and took the exclusion again.

“The timing is the key, in how you use the home,” Ms. Lauridsen said. “It wouldn’t have worked if they sold both homes at the same time.”

Sometimes, however, the tax may be unavoidable. “This has been a topic of discussion many times in the past year and is going to continue to be one as the housing prices in California continue to skyrocket,” said John P. Schultz, a certified public accountant in Ontario, Calif.

“Given concerns about recently rising housing prices and inflation in general,” a recent report from the Congressional Research Service said, “policymakers may wish to reconsider” the caps of $250,000 and $500,000.

If the exclusion amounts had been increased to reflect the change in the “average housing price” from 1998 to 2021, the report said, they would now be $650,000 for single homeowners and $1.3 million for married couples.

See the article here.

By Ann Carrns

Published March 25, 2022