Selling My House with $800k in Profits - Is There a Tax-Free Way to Downsize?

Eric Reed
6 min read

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When you sell a primary residence, the IRS allows you to exclude from your capital gains taxes the first $250,000 of profits if you file single or $500,000 of profits if you file jointly. You must include any surplus of those amounts in your taxable capital gains for the year, though. So, what if you sell your house for an $800,000 profit? You will probably owe taxes on a good portion of that sale, although you’ll get a significant tax break in the process.

Do you have questions about downsizing for retirement or retirement planning in general? Speak with a financial advisor today.

How Capital Gains Work on a Home Sale

When you sell any asset, including anything from real estate to investments to personal property, the profits are considered capital gains. The IRS calculates those profits as the following:

Sale Price – Tax Basis = Taxable Capital Gains

The sale price is whatever amount you received for selling the property, and the tax basis is the amount of capital you have invested in the underlying asset. For real estate, this generally includes:

  • The price paid to buy it, including legal fees, title insurance and costs of setting up necessary services like utilities

  • Costs of improvements and upgrades to the building or property (generally considered any costs that improve the property or extend its lifespan)

  • Some costs involved with selling the property, including realtor’s fees, advertising and costs involved with showing the property

However, this generally does not include property taxes, financing or interest costs, costs of use and occupancy and necessary maintenance.

So, for example, say that you buy a house for $500,000. You then have the following hypothetical expenses:

  • $40,000 of mortgage interest

  • $25,000 to remodel the kitchen

  • $10,000 to install a new boiler when the old one breaks

  • $6,000 to repair a weak point in the roof

If you now sell the house, your cost basis would be $535,000, as the home cost you $500,000 and the kitchen and boiler both count as upgrades to the property ($25,000, plus $10,000). Even though the old boiler was broken, by installing a new one rather than repairing the old it counts as an update.

Your financing costs do not count, nor do the necessary repairs you made to the roof. Repairs are considered costs to maintain the property’s existing value rather than upgrades to improve the property’s value.

If, down the road, you then sell the house for $700,000, you would have $165,000 of potentially taxable capital gains ($700,000 – $535,000 = $165,000).

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