Capital Gains Tax: The Bane of Today’s Home Seller

April 19, 2023

A Double-Edged Sword

I once read an inspirational quote that said, “Be thankful that you are paying taxes, because that means you are making money”. Now, I don't know very many people that feel “inspired” when they are opening up their checkbooks around tax time, but it brings up an interesting paradox for homeowners who have lived in an area where the value of homes has increased almost exponentially over the past several decades: You're going to make a nice profit when you sell your home, but you'll also likely be writing a hefty check to the state and federal governments in the form of capital gains tax.

So much for feeling thankful.

Capital gains taxes are nothing new, but up until the past few decades it wasn't a topic that homeowners paid much heed to. Why? One of the biggest perks of owning a home is that the first $250,000 of profit that each owner makes ($500,000 profit for a married couple) from the sale of their home is free of capital gains tax. It's one of the few gifts of home ownership that the government hasn't taken away (but not for lack of trying).

Not many people who bought their homes many years ago could have fathomed that their little San Carlos cottage would ever appreciate by over $500,000. But then along came Silicon Valley, and during those boom years homes appreciated by that much (or more) in a single year.

If you're hoping that I have magic formula for you to avoid paying capital gains on the sale of your primary home, I'm sorry to disappoint you. The government has sealed up any of those loopholes a long time ago. The purpose of this post is to give a you one big tip that will help minimize your tax liability when you do sell:

Keep Excellent Records.

Those three words are the advice that I give every new homeowner when I hand them the keys to their place. From the minute you take ownership of your new home, keep excellent records of every improvement that you make to the house. I'll talk in a minute what I mean by “excellent records”.

There are two reasons why this is very important.

First, your capital gains liability is calculated on the profit that you made on the sale of your home, which is roughly the difference between what you bought your home for versus what you sold it for, minus the aforementioned exemption AND any improvements that you made to the house while you lived there. In a highly simplified equation, it looks like this:

Profit = Sales price – purchase price – exemptions – improvements.

That very last point is what this article is all about. What you purchased the house for, what you sold it for, and the exemptions are all discrete numbers that are readily available. But where most homeowners fall down is not keeping good records on improvements that they made to their homes, and that's tragic because that dollar amount can and should be deducted from your capital gains liability.

That $20,000 for putting on a new roof? Check. The kitchen remodel, new windows? Ditto. If you don't keep excellent records on what you did to your home, it's really hard to claim those deductions later when you file your taxes.

Many people in that situation just make estimates of what they spent on capital improvements, and that may suffice — until your taxes get audited (speaking from experience here). The IRS is very particular about having documentation to back up your deduction, and the less documentation you have, the lighter your wallet is going to be after the audit is done.

The second reason for keeping excellent records has nothing to do with taxes and everything to do with your disclosures when you sell your home. When a buyer sees a concise, chronologically sorted spreadsheet of all the home improvements, it instills confidence that you took good care of the house, and that usually results in more interested buyers and ultimately a higher sales price.

What are “Excellent Records”?

At a minimum, I tell my clients to do two things. First, start a simple spreadsheet that keeps chronological tabs on every improvement they make. At a minimum, have columns for what work was done, who did it, when it was done, and what it cost. Put EVERYTHING into that spreadsheet, even things as simple as the cost of painting a kids room, or replacing an appliance. Your accountant can scrub the list of what can be deducted versus what can't, so over-document those things.

Second, and just as important, save and store ALL of your receipts to back up the figures in the spreadsheet. With scanning apps and cloud storage, that's super easy to do with today's technology. Just put everything into a single DropBox folder and you won't need to keep a single scrap of paper.

If you're one of those long-time homeowners who hasn't been doing this, it's never to late to start. You'd be surprised at how much documentation you can dig up between your credit card statements and even going back and pulling old receipts. But don't procrastinate on this — many contractors only keep records for 7-10 years on their projects, so if you have waited too long they may not be able to help you produce the documentation you'll need.

A Disclaimer.

I'm a Realtor, not a tax expert. You should address any questions regarding capital gains to your CPA or tax attorney, including what can or cannot be deducted, and even what your cap gain rate. The latter can vary widely depending on your income, how large the gain is, and whether it is a short-term or long-term gain.

My advice here is simply this: Keep excellent records so that you're in a position to even have that discussion with your tax pro, and of course to get every possible tax break that you can.

Posted in:


  1. Anonymous on April 19, 2023 at 3:39 pm

    Very good tip. It should also be mentioned that there is a difference between an improvement and a repair. Only improvements can reduce your cost basis. An improvement is work that prolongs the life of the property, enhances its value or adapts it to a different use. On the other hand, a repair keeps property in efficient operating condition.

  2. Chuck Gillooley on April 20, 2023 at 7:08 pm

    Thanks for your comment. That’s an excellent point you brought up about the difference between repairs and improvements. It’s still a good habit to document both, because while the repairs may not be relevant for the purposes of lowering the tax basis, it’s very relevant for documenting the property history when it’s time to put it up for sale. Just let your CPA decide which is which.

Leave a Comment