You've Owned Your Home for 20 Years. How Much of Your Profit Will You Actually Keep?

Introduction

Your home may be worth two or three times what you paid for it. That is wonderful news, especially if you are thinking about downsizing. Before you plan around that equity, there is a federal tax rule every longtime homeowner should understand.

This article explains the home sale exclusion, what Washington does and does not tax, and the one set of records that can save you real money.

Quick answer: Many longtime owners pay no federal tax on their gain because of the $250,000 single or $500,000 married exclusion. Washington's capital gains tax does not apply to real estate. Gains above the exclusion may be taxed federally, and your improvement records lower the gain, so gather them before you list.

What Is the Federal Home Sale Exclusion?

Under Section 121 of the Internal Revenue Code, homeowners who sell their primary residence can exclude a significant portion of the gain from federal income tax.

• Single filers: up to $250,000 of gain
• Married couples filing jointly: up to $500,000 of gain

To qualify, you generally must have owned and used the home as your primary residence for at least two of the five years before the sale, and you generally cannot have used the exclusion on another home sale within the past two years. If your gain is below the exclusion amount, you generally owe no federal capital gains tax on the sale.

Why Are More Seattle Area Sellers Exceeding the Exclusion?

The $250,000 and $500,000 limits were set in 1997 and have never been adjusted for inflation. Home values in our region have grown a great deal since then, so the exclusion protects a smaller share of real world appreciation in higher cost markets.

That is why I encourage longtime owners I work with in Bothell, Edmonds, Kirkland, Bellevue, Woodinville, Lynnwood, Everett, Brier, Mountlake Terrace, Redmond, Mill Creek, and Seattle to estimate their gain before they list.

Proposals to raise or eliminate the tax on home sales have been discussed nationally. As of this writing, none have become law, so plan with the current rules.

Does Washington's Capital Gains Tax Apply to Selling a Home?

Washington has a state capital gains excise tax, and many homeowners worry are Not aware of this When they sell their home.. State law exempts exchanges of real estate from that tax, However, everyone else is required to pay the sales tax when they sell their home.

Washington's real estate excise tax, called REET, which is a separate tax on the sale itself and is typically paid by the seller at closing. I explain REET and other closing costs in my article on how much you will net when selling your home.

How Do I Calculate My Gain?

Your gain is not simply the sale price minus what you paid. Here is the basic formula.

1. Find your adjusted cost basis. It generally includes your original purchase price, certain purchase closing costs, and the cost of capital improvements over the years.
2. Subtract selling costs. These generally include real estate commissions, excise tax, escrow and title fees, and other qualifying costs of sale.
3. Calculate the gain. Sale price, minus selling costs, minus adjusted basis, equals your gain.

A Local Example

Consider a married couple who bought their Bothell home in 1999. This is an illustration with round numbers.

• Purchase price: $260,000
• Purchase closing costs: $7,000
• Capital improvements over the years (kitchen remodel, roof, addition, windows): $120,000
• Adjusted basis: $387,000

They sell today for $1,150,000, with about $69,000 in selling costs.

• $1,150,000 minus $69,000 minus $387,000 equals a gain of $694,000
• Minus the $500,000 married exclusion leaves $194,000 of taxable gain

If that gain is taxed at the 15 percent long term capital gains rate, the federal tax would be about $29,000. Higher income households may also owe the 3.8 percent net investment income tax on part of the taxable gain, and some pay a higher rate. Your CPA can calculate your exact amount.

Without their improvement records, this couple's gain would have been $120,000 higher. That leads to the most important tip in this article.

Do Home Improvements Reduce Capital Gains?

Yes. most capital improvements add to your basis and can significantly reduce your taxable gain. Examples often include:

• Additions and finished basements
• Kitchen and bathroom remodels
• New roofs, windows, and siding
• New heating systems, heat pumps, or water heaters
• Landscaping, fencing, decks, and patios
• Seismic retrofits and new sewer lines

Routine repairs and maintenance, such as painting a room or fixing a leak, generally do not count. Your tax professional can help you sort the difference. Start a file now, gather receipts, invoices, permits, and bank records now. Your future self will thank you.

What Special Situations Should Every Seller Know?

When a Spouse Passes Away

A surviving spouse may still be able to use the full $500,000 married exclusion if the home is sold within two years of the spouse's death and other requirements are met, including not having remarried. This rule matters a great deal for widowed homeowners deciding when to sell.

Inherited Homes

Inherited property generally receives a stepped up basis to its value at the time of death, which can greatly reduce taxable gain for heirs. I cover the full process in my guide to selling an inherited home or a home in probate.

Divorce

When one spouse keeps the home after a divorce and sells later, that person may be limited to the $250,000 single exclusion. Timing within a divorce settlement can matter, and both an attorney and a tax professional should be involved.

Partial Exclusions

If you must sell before meeting the two year rule because of a job change, health reasons, or certain unforeseen circumstances, you may qualify for a reduced exclusion based on how long you lived in the home.

Rental or Home Office Use

If part of your home was used as a rental or business, different rules may apply, including depreciation recapture. This is an important conversation for your CPA.

How Can Longtime Homeowners Reduce Capital Gains?

These are strategies longtime homeowners commonly discuss with their tax advisors.

• Organize your basis records early. This is the simplest and often most valuable step.
• Consider timing. Selling in a year when your other income is lower may reduce the rate on any taxable gain.
• Offset with investment losses. Capital losses from other investments may offset taxable gain above the exclusion.
• Plan around life events. The surviving spouse rule and the partial exclusion rules can change the best timing.
• Coordinate with your next move. Buying, renting, or moving closer to family each affects your overall picture.

For investment properties, a 1031 exchange may defer taxes. That strategy generally does not apply to a primary residence, and I explain it in my separate guide to 1031 exchanges.

How Does a Realtor Help With Tax Smart Selling?

I do not give tax advice, and I encourage every client to work with a CPA. Here is how I help alongside your tax professional:

• Estimating your sale price with accurate, current comparable sales
• Estimating your selling costs, including commissions, excise tax, and escrow fees
• Helping with timing so your sale lines up with your tax and life plans
• Connecting you with trusted local professionals, including CPAs, estate attorneys, and financial advisors

Coordinating early helps sellers avoid surprises and make informed decisions before closing.

What Are the Most Common Capital Gains Mistakes?

• Throwing away improvement receipts that could raise your basis
• Counting routine repairs as improvements
• Assuming Washington's capital gains tax applies to a home sale
• Selling just before meeting the two year ownership and use rule
• Forgetting the real estate excise tax, which is separate

Frequently Asked Questions

Do I pay capital gains tax when I sell my house in Washington?

Many homeowners pay no federal capital gains tax because of the $250,000 single or $500,000 married exclusion. Gains above those amounts may be taxed federally. Washington's state capital gains excise tax exempts real estate sales.

What is the $250,000 and $500,000 home sale exclusion?

Under Section 121, homeowners who owned and lived in their primary residence for at least two of the past five years can generally exclude up to $250,000 of gain if single, or $500,000 if married filing jointly.

How do I calculate my gain on a home sale?

Subtract your selling costs and your adjusted basis from your sale price. Your adjusted basis includes your purchase price, certain purchase closing costs, and capital improvements.

Do home improvements reduce capital gains?

Yes. Capital improvements such as additions, remodels, new roofs, and new systems generally increase your basis and reduce your taxable gain. Keep receipts and records.

What happens to the exclusion when a spouse passes away?

A surviving spouse may generally use the full $500,000 exclusion if the home is sold within two years of the spouse's death and other requirements are met.

How can longtime homeowners reduce capital gains when selling?

Gather improvement records, consider sale timing, offset gains with investment losses, and work with a CPA on strategies specific to your situation.

Ready to Plan Your Next Chapter?

If you have owned your home for many years and are thinking about what comes next, I would love to help you estimate your sale price and connect you with trusted professionals so you can plan with confidence. I'm Cheryl Dillon, a residential Realtor serving Greater Seattle, the Eastside, and Snohomish County. I enjoy helping people. Whether you're considering buying, selling, or simply exploring your options, I'd love to connect and help you take the next step with confidence.

Phone: 425.954.5622

Email: Cheryl@CherylDillonRealEstate.com

Website: CherylDillonRealEstate.com

I am Cheryl Dillon a licensed REALTOR® in the state of Washington with eXp Realty.