Can I Deduct Realtor Fees From Capital Gains?
Understand how selling costs and property upgrades affect your real estate capital gains calculation and tax liability.
When you sell a home or other real estate, the profit you make is often subject to capital gains tax. This tax applies to the difference between your selling price and your adjusted cost of the property. Understanding how these gains are calculated is important for homeowners, as it can significantly impact the financial outcome of a sale.
What Are Capital Gains on Real Estate
A capital gain on real estate represents the profit realized from the sale of a property. It is generally calculated as the difference between the selling price of the asset and its adjusted basis.
The original basis of a property typically includes the purchase price. This initial cost can also incorporate certain acquisition expenses, such as title insurance, legal fees, recording fees, and survey fees. For example, if a property was purchased for $300,000, this amount forms the core of its original basis.
Over time, this original basis can be adjusted. A higher adjusted basis can help reduce the taxable gain when the property is eventually sold. The fundamental calculation for a capital gain before any further adjustments is the selling price minus the original basis.
How Selling Expenses Reduce Capital Gains
Realtor fees, commonly known as real estate commissions, are significant expenses incurred during a property sale. These fees are not directly deducted from your income on a tax return. Instead, they reduce the “amount realized” from the sale, which in turn lowers the overall capital gain.
For example, if you sell a property for $500,000 and pay $30,000 in realtor commissions, the amount realized for tax purposes becomes $470,000. This reduced figure is then used in the capital gain calculation, leading to a lower taxable profit.
Other common selling expenses also reduce the amount realized from the sale, functioning similarly to realtor fees. These can include legal fees paid at closing, advertising costs for the property, and expenses associated with home staging. Transfer taxes and escrow fees, if paid by the seller, also fall into this category.
These various selling expenses are subtracted from the gross sales price of the property before the capital gain is determined. Maintaining thorough records of all selling expenses is important for accurate tax reporting.
Increasing Your Basis with Capital Improvements
Capital improvements are expenses that add value to your home, prolong its useful life, or adapt it to new uses. These are distinct from routine repairs, which merely maintain the property’s current condition. For instance, fixing a leaky faucet is a repair, while replacing an entire plumbing system is a capital improvement.
Examples of qualifying capital improvements include major renovations like adding a new room, remodeling a kitchen or bathroom, or replacing the roof. Upgrades to essential systems such as heating, ventilation, and air conditioning (HVAC), electrical wiring, or plumbing also count. Energy-efficient upgrades, such as installing new windows or insulation, can also qualify.
The costs of these improvements are added to your property’s original basis, increasing it. A higher adjusted basis means a smaller difference between the selling price and the cost, thereby reducing the capital gain. It is advisable to keep detailed records, including receipts and invoices, for all capital improvements made to the property.
Determining Your Taxable Capital Gain
It begins with the gross sales price, from which all eligible selling expenses are subtracted. This net sales figure then has the adjusted basis deducted, which includes your original purchase price plus the cost of any capital improvements.
The formula can be expressed as: (Gross Sales Price – Selling Expenses) – (Original Basis + Capital Improvements) = Taxable Capital Gain. For example, if a property sold for $500,000, incurred $40,000 in selling expenses, had an original basis of $300,000, and $50,000 in capital improvements were made, the calculation would be ($500,000 – $40,000) – ($300,000 + $50,000) = $460,000 – $350,000 = $110,000 taxable capital gain.
This calculated gain is then subject to capital gains tax rates. The specific rate depends on how long you owned the property; gains from assets held for one year or less are considered short-term and are taxed at ordinary income rates, while those held for more than a year are long-term capital gains, typically taxed at lower, preferential rates.