With any luck, you might be able to walk away from the sale of your principal residence without paying any capital gains tax. The current law allows qualified married couples filing jointly to pull down a tax-free profit of up to $500,000 ($250,000 for single filers).
But you could still owe tax on a home sale. That's because your "gain" for tax purposes is the difference between the sale price (less certain selling expenses) and your "basis" in the home.
If your gain exceeds the home sale exemption limit, or if you owe capital gains tax due to the business use of your home, you could wind up with a tax bill.
Tip: Scour your records and files for home improvements and other outlays that can be used to increase your basis. It doesn't matter if the costs were incurred years ago. The more you can add to your basis, the less your taxable gain.
The list of home improvements includes new additions, installation of central air conditioning, fencing, decks, heating or plumbing systems and landscaping. But the cost of repairs, such as repainting the house or fixing roof shingles, can't be added to the basis.
"Selling expenses" can also be subtracted. These include attorney's fees, title search and insurance, broker's commissions, survey and appraisal fees, and fees for recording deeds and mortgages.
You can add the cost of home improvements to the basis to reduce your taxable gain when you sell a home. But can you increase your basis when you make related improvements on "common" property? That was the issue raised in an IRS private letter ruling
A taxpayer bought a residence on a bluff of land overlooking a river. When he found out the bluff was eroding and the home was at risk, he obtained permits from local authorities to build a bulkhead and shore up the property. The actual improvements were made on common land that the taxpayer didn't own. Later, the taxpayer sold the home at a sizeable gain.
The IRS determined that the construction project improved the home by stabilizing the shoreline and protecting the structure from future damage. Therefore, the improvements were capital in nature and can be added to the home's basis. (IRS PLR 200229014)
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