We’re downsizing. How do we calculate capital gains?

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Q. My husband and I are in our early 70s and have lived in our current residence for more than 25 years. We are considering downsizing to a smaller house in either New Jersey or Pennsylvania. I know that we can exclude up to $500,000 as a married couple filing jointly from capital gains on the federal and New Jersey tax returns. What is the rest of the calculation?
— Moving soon

A. Congrats on making this big move.

There are several parts to the calculation for tax purposes.

First, as you believed, IRS rules allow you to exclude the first $500,000 of capital gains – or $250,000 for single tax filers – from the gain on the sale of your home, said Deva Panambur, a certified financial planner with Sarsi, LLC in West New York. and adjunct professor of personal finance at Montclair State University.

“You are eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years before the date of the sale,” he said.

If you don’t meet the eligibility test, Panambur said, you may still qualify for a partial exclusion of gain. He said you can meet the requirements for a partial exclusion if the main reason for your home sale was a change in workplace location, a health issue or an unforeseeable event.

The gain is calculated as the selling price minus selling expenses minus adjusted basis, he said.

“Selling expenses include any sales or commissions incurred for the sale, legal fees, any mortgage points or mortgage expenses you paid that would normally have been the buyer’s responsibility and any other fees or costs incurred to sell your home,” he said.

To calculate your adjusted basis, you can include many, but not all, costs associated with the purchase and maintenance of your home.

Costs associated with purchase include settlement fees and closing costs, charges for installing utility services, legal fees – including fees for the title search and preparing the sales contract and deed – recording fees, survey fees, transfer or stamp taxes and owner’s title insurance.

He said you can’t include costs such as fire insurance premiums, rent for occupancy of the house before closing, charges for utilities or other services related to occupancy of the house before closing, or any fee or cost that you deducted as a moving expense (which was allowed for certain fees and costs before 1994). You also can’t include charges connected with getting a mortgage loan, such as mortgage insurance premiums and loan assumption fees.

Some maintenance costs incurred for improvement to the home can be added to your basis, including those that add the value of your home, prolong its useful life or adapt it to new uses, he said. This includes adding a bedroom, landscaping, and new heating or cooling systems.

“You can’t include any costs of repairs or maintenance that are necessary to keep your home in good condition but don’t add to its value or prolong its life,” he said. “Examples include painting the interior or exterior, fixing leaks, filling holes or cracks, or replacing broken hardware.”

Also excluded are the costs of any improvements that are no longer part of your home such as wall-to-wall carpeting that you installed but later replaced and any costs of any improvements with a life expectancy, when installed, of less than one year, Panambur said.

Also note that New Jersey uses the same method for calculating the gain on sale of home, he said.

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This story was originally published on Sept. 12, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.