Can You Deduct Real Estate Commissions From Capital Gains?

When selling real estate, understanding the tax implications is important. Sellers should consider how the sale affects their capital gains, as certain expenses can influence the amount of taxable gain. Knowing which costs are relevant and how they are applied helps in preparing for the financial outcomes.

Understanding Capital Gains on Real Estate Sales

Capital gains refer to the profit realized from the sale of an asset, such as real estate, when the selling price exceeds its original cost. For tax purposes, the calculation is: Selling Price minus Adjusted Basis equals Capital Gain or Loss. This calculation determines any potential tax liability.

The length of time a property is held before sale distinguishes between short-term and long-term capital gains. Short-term gains apply to assets held for one year or less, while long-term gains are for assets held for more than one year. These distinctions influence the applicable tax rates.

Identifying Allowable Selling Expenses

Real estate commissions and other selling expenses are not deducted from a seller’s income. Instead, these costs reduce the gross selling price of the property, which lowers the calculated capital gain. This distinction is important for accurate tax reporting.

Allowable selling expenses include costs associated with the transaction. Examples are real estate agent commissions, legal fees, title insurance fees, escrow fees, transfer taxes, and recording fees. Costs that do not physically improve the property, such as advertising or appraisal fees, can also be included.

These selling expenses differ from other costs. Capital improvements, which add value or prolong the property’s useful life, are added to the property’s basis, rather than reducing the selling price. Routine maintenance or staging costs are not considered deductible or basis-increasing expenses for capital gains purposes.

Calculating Your Real Estate Capital Gain

Calculating a real estate capital gain involves a step-by-step process that accounts for both the net selling price and the property’s adjusted basis. First, determine the Net Selling Price by subtracting all allowable selling expenses from the gross selling price.

Next, determine the Adjusted Basis of the property. This includes the original purchase price, along with certain acquisition costs like legal fees and title insurance. The cost of any capital improvements made during ownership, such as a new roof or a room addition, also increases the adjusted basis.

Finally, calculate the Capital Gain or Loss by subtracting the Adjusted Basis from the Net Selling Price. For example, if a property sells for $400,000, and selling expenses are $20,000, the Net Selling Price is $380,000. If the Adjusted Basis is $250,000, the capital gain would be $130,000 ($380,000 – $250,000).

Required Documentation for Reporting

Maintaining thorough documentation is important for accurately reporting a real estate sale on a tax return. Key documents include closing statements, such as the HUD-1 Settlement Statement or the Closing Disclosure, from both the original purchase and the recent sale. These statements detail transaction costs, including selling expenses and acquisition costs that factor into the basis.

Receipts for any capital improvements made during ownership are also necessary. These records substantiate additions to the property’s adjusted basis, which can reduce the taxable gain. Keeping these documents organized helps verify the figures reported to the Internal Revenue Service (IRS) and is important in case of an audit.

Reporting the Sale on Your Tax Return

Reporting a real estate sale on a tax return involves specific IRS forms to convey financial details. Primary forms used are Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. Form 8949 details individual transactions, including the sales price and the cost or other basis of the property.

The Net Selling Price and Adjusted Basis, calculated using the methods described previously, are entered onto Form 8949. This form categorizes the sale as either a short-term or long-term transaction based on the holding period. The totals from Form 8949 are then transferred to Schedule D, where the overall capital gains or losses for the tax year are summarized. If a Form 1099-S, Proceeds From Real Estate Transactions, was received, the sale must be reported even if the gain is excludable.