Major Transitions
Selling a Home or Property: Questions to Ask Before the Money Arrives
The planning that matters most happens before the closing, not after.
The capital gains question
For most homeowners, the primary tax question in a home sale is capital gains. The federal exclusion — $250,000 for single filers, $500,000 for married couples filing jointly — applies to the gain on the sale of a primary residence, provided you have owned and lived in the home for at least two of the five years before the sale. In Los Angeles, where home values have appreciated significantly over the past two decades, many homeowners have gains that exceed the exclusion. The portion above the exclusion is taxable — at federal capital gains rates and California ordinary income rates.
Basis: what you actually paid
Your taxable gain is the sale price minus your adjusted basis — not just what you originally paid. The adjusted basis includes the original purchase price plus the cost of capital improvements made over the years. Keeping records of major improvements — a kitchen remodel, a room addition, a new roof — can meaningfully reduce your taxable gain. Many homeowners do not have complete records of their improvements, which results in a higher reported gain than necessary.
Investment property: different rules
The primary residence exclusion does not apply to investment property. The sale of a rental property or investment real estate is subject to capital gains tax on the full gain, plus depreciation recapture — a tax on the depreciation deductions taken over the years of ownership. A 1031 exchange can defer the gain by reinvesting the proceeds into a like-kind property, but the rules are strict and the timeline is short. These are questions for a tax advisor and a financial planner working together.
What to do with the proceeds
A large lump sum from a real estate sale creates a planning opportunity and a planning challenge simultaneously. The opportunity: a significant influx of capital that can be deployed toward retirement savings, debt reduction, or investment. The challenge: the temptation to spend it, the tax consequences of investing it all at once, and the difficulty of deciding what to do with money that feels different from regular income. Having a plan for the proceeds before the sale closes is far better than making decisions under the pressure of a large bank balance.
Timing considerations
The year in which a sale closes determines the tax year in which the gain is recognized. If you are close to a year-end and have flexibility on closing timing, it may be worth considering whether closing in the current year or the following year produces a better tax outcome — particularly if your income is unusually high or low in one of those years. This is a question for a tax advisor, but a financial planner can help frame the analysis.
A real estate sale is one of the largest financial transactions most people will make. The questions worth asking are the ones that need answers before the closing date, not after.
If you are planning a real estate sale and have not reviewed the tax and planning implications, that is worth doing before you list.
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