What Happens to the Equity in My House When I Sell?
Uncover the real financial outcome of selling your home. Learn how your equity is realized after accounting for all expenses and tax considerations.
When selling a home, understanding what happens to your equity is important for financial planning. Home equity represents a significant portion of many homeowners’ wealth. This article explores how home equity is realized when a property is sold, detailing the costs involved, the calculation of net proceeds, and potential tax implications.
Understanding Home Equity
Home equity is the portion of your home’s value that you own outright. It is the difference between the current market value of your home and the outstanding balance of any loans or liens against it. For example, if a home is valued at $400,000 and the outstanding mortgage is $150,000, the equity would be $250,000.
Equity grows in two primary ways. First, as you make mortgage payments, a portion of each payment reduces the principal balance of your loan, directly increasing your ownership stake. Second, property value appreciation over time also contributes to equity growth, as the market value of your home increases while your debt remains constant or decreases. This equity serves as a valuable asset that can be accessed or realized upon the sale of the property.
Costs When Selling Your Home
Selling a home involves several expenses that reduce the gross sale price. One of the largest costs is real estate agent commissions, which range from 5% to 6% of the home’s sale price, often split between the seller’s and buyer’s agents. For example, on a $400,000 home, this could amount to $20,000 to $24,000.
Additional expenses include closing costs for sellers, which can range from 1% to 3% of the sale price. These cover escrow fees, title insurance, attorney fees, and recording fees. Transfer taxes are one-time fees imposed by state or local jurisdictions upon the transfer of property ownership, and these vary significantly by location. Sellers might also incur costs for agreed-upon repair credits or concessions to the buyer, as well as prorated property taxes or homeowners association (HOA) fees that need to be settled at closing.
Calculating Net Proceeds
After understanding the various costs associated with selling a home, the next step is to calculate the net proceeds, which is the actual cash amount a seller receives. This calculation begins with the gross sale price of the home. From this amount, the outstanding balance of all mortgages and any other liens against the property are subtracted.
Total selling costs are then subtracted. These costs include real estate agent commissions, seller closing costs such as escrow and title fees, transfer taxes, and any agreed-upon repair credits or prorated property expenses. The resulting figure represents the net proceeds from the sale, after all obligations tied to the sale are settled.
Tax Implications of Your Home Sale
Selling your home can have tax consequences concerning capital gains tax on any profit realized from the sale. Capital gains are the profits made when an asset, such as a home, is sold for more than its adjusted cost basis. Many homeowners can exclude a significant portion of this gain from their taxable income.
Under Internal Revenue Code Section 121, single filers can exclude up to $250,000 of capital gains, while those married filing jointly can exclude up to $500,000. To qualify for this exclusion, the home must have been owned and used as the principal residence for at least two out of the five years preceding the sale. If the gain exceeds these exclusion limits, the excess amount may be subject to capital gains tax rates, which can vary based on income and how long the property was held. The entity responsible for closing the transaction reports the gross proceeds from the sale to the IRS on Form 1099-S.