Capital Gains Tax on Sale of Home Involving a Deed Transfer

The sale of your home and the resulting deed transfer can have tax consequences. If your home is worth more than you paid for it, the sale might result in a capital gain -- a profit generated by the difference between your home’s cost and the price at which you sell it. Whether or not your sale is subject to capital gains tax depends primarily on the amount of your gain. Although the type of deed you use to transfer ownership has no bearing, a general understanding of deed transfers and the process for determining capital gains will ease you through the sale process and help you avoid unpleasant surprises at tax time.

Deeds Overview

A deed is a legal document that transfers ownership interest from one party to another. Several types exist. A general warranty deed guarantees that there are no liens or other encumbrances on a property except those described in the deed. It offers the highest assurance of clear title. A special warranty deed falls short of the sweeping guarantees of a generally warranty deed. It states that the seller has title to the property and that the property has not been encumbered during his period of ownership except as stated in the deed. A bargain and sale deed merely implies that the seller has title to the property, without making claims as to whether or not the title is clear. A trust deed secures a loan, much like a mortgage, until the loan has been repaid. Finally, a quitclaim deed transfers whatever interest an individual holds, without implied or expressed warranty. Thus, if an individual actually has no interest, no interest is transferred.

Deed Transfer

A valid deed must conform to certain rules. First, it must have a "legal description" of the property. The legal description gives its location in a more formal and precise way than an address. The deed must also specify the "consideration" or payment the buyer gave the seller in exchange for title. Payment can be "valuable consideration," like money, or it can be "good consideration," such as love or affection. In addition, the deed must name the grantor, the person who is granting title, and the grantee, the person receiving the title. Once both grantor and grantee have signed the deed, it should be recorded with the recorder of deeds in the county where the property is located. Whether or not a deed must be recorded to be valid depends on state law. However, all deeds should be recorded so that a complete record exists of the property's chain of ownership.

Capital Gains Tax

Once the sale has closed and the deed has been recorded, it’s time to think about the possibility that you’ll owe capital gains tax on your profit from the sale. You're entitled to an exemption if the sale resulted in less than $250,000 gain, the home was your primary residence and you've not been exempt from capital gains resulting from the sale of another home within the past two years. This amount is for single filers or married taxpayers filing separate returns. If you're married and file a joint return, you can exclude up to $500,000 of capital gains. You may qualify for a reduced exemption if you don't meet all the criteria for the full one. You'll report your capital gain using IRS Form 1040 Schedule D, which includes worksheets to help you do the calculations.

Adjusted Basis

The adjusted basis is the net cost of your home. It's the starting point for determining capital gain on a home's sale. To figure your adjusted basis, add the basis -- the purchase price -- and any closing costs other than those associated with your loan and escrowed funds for future tax or insurance payments. Among the closing costs the IRS allows are those for title work, utility installation, deed recording, surveys, transfer tax, owner's title insurance and any seller costs you agree to pay on the seller's behalf. Also add the cost of improvements you made to your home that have a useful life of more than one year, were part of a special tax assessment or restored your property after a casualty loss. Deduct from the total any mortgage points the seller paid on your behalf if you purchased your home before 1990 or after April 3, 1994. If you purchased your home after 1990 but before April 3, 1994, only deduct the points from your basis if you deducted them on your tax return as mortgage interest. The amount that remains is your adjusted basis.

Figuring Capital Gain

The first step toward figuring your gain is to find the "amount realized" from the sale. Begin with the selling price -- the full amount the buyer paid, whether in cash or with a loan. Subtract from this price the costs associated with selling, such as your real estate broker's commission, legal fees and closing costs you paid on the buyer's behalf, such as points. The result is the amount realized. To determine your gain, subtract the adjusted basis from the amount realized.

References

• Oregon State Bar Associaton: "Legal Issues for Older Adults"
• IRS.gov; Publication 523, Selling Your Home; 2010