Do Real Estate Commissions Reduce Capital Gains?

When selling real estate, understanding how various costs impact the financial outcome is important. Homeowners often encounter terms like capital gains, which represent the profit made from such a sale. Properly accounting for expenses incurred during the transaction can significantly alter the amount of reported gain. This knowledge helps individuals accurately calculate their tax obligations after selling a property.

Understanding Real Estate Capital Gains

A capital gain arises when the net amount received from selling real estate exceeds its adjusted cost. This calculation begins with the “amount realized,” which is the gross selling price of the property less certain expenses incurred during the sale. The “adjusted basis” represents the original cost of acquiring the property, plus the cost of any capital improvements made over time, reduced by certain deductions like depreciation. For instance, if a property sells for $400,000 and the amount realized after expenses is $370,000, while its adjusted basis is $250,000, then the capital gain would be $120,000. The Internal Revenue Service (IRS) provides guidance on these calculations, in Publication 523, “Selling Your Home.”

How Selling Expenses Reduce Capital Gains

Real estate commissions are a primary example of “selling expenses” that directly reduce the amount realized from a property sale. Other common selling expenses also play a role. These can include legal fees, certain title insurance premiums, advertising costs, and transfer or stamp taxes paid by the seller. For example, if a home sells for $500,000 and the seller pays $30,000 in real estate commissions, along with $5,000 in other selling expenses, the amount realized would be $465,000. Properly tracking and documenting all selling expenses is important for accurate tax reporting.

Adjusting Your Property’s Basis

The basis of a property starts with its original cost, which includes the purchase price and certain acquisition costs like abstract fees, survey fees, recording fees, and legal fees related to title acquisition. Adjusting the basis accounts for specific financial events that either increase or decrease the property’s value for tax purposes.

The basis increases with capital improvements, which are additions or renovations that add to the property’s value, prolong its useful life, or adapt it to new uses. Examples include installing a new roof, adding a room, replacing the entire heating and air conditioning system, or making substantial landscaping improvements. These expenditures are not immediately deductible but are added to the property’s basis, as detailed in IRS Publication 551, “Basis of Assets.”

Conversely, the basis must be decreased by certain deductions, most notably depreciation if the property was used for business or rental purposes. Depreciation deductions reduce the property’s adjusted basis over time, reflecting wear and tear or obsolescence. A higher adjusted basis ultimately results in a smaller capital gain when the property is sold, which can affect potential tax liability.