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Can We Avoid a Huge Tax Bill on the Sale of Mom’s House?

Taxes

Can We Avoid a Huge Tax Bill on the Sale of Mom’s House?

Dana Miranda, CEPF®

Dear Penny,

My mother’s house is currently worth between $2 million and $3 million. My parents bought it for much less than that. She will turn 80 this year and won’t be in that large house for too much longer. Is there a way for her to avoid a huge capital gains bill when she eventually sells it?

– Mother’s Helper

Dear Helper,

Congrats to your mother on the appreciation of her property! Owning a home has been an important path to wealth building for American families for several generations, and the opportunity to see significant growth in value (through luck, investment or sweat equity) is increasingly rare, so she’s in a fortunate position.

What your mother might consider a “huge” capital gains tax bill is subjective, but I can tell you what to expect when she sells the house and how to prepare.

A homeowner can profit pretty significantly from a sale without incurring taxes. In most cases, selling your primary residence for a profit isn’t subject to any tax. The capital gains tax isn’t meant to disrupt a person’s ability to move from home to home, but it’s set up to collect tax on money gained from wealth-building assets. As such, selling a property you owned only briefly or one you never lived in is usually subject to taxes — as ordinary income if you owned it less than a year, as capital gains if you owned it for more than a year.

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It sounds like your parents bought the house your mother is living in a long time ago and have been living in it as their primary residence since then. If that’s the case, the sale can qualify for a capital gains exclusion on $250,000 in gains (i.e. the difference between the purchase price + cost of improvements, and the sale price). If your mother is filing jointly with a spouse, that exclusion applies to $500,000 in gains.

If your mother profits more than that on the sale, she’ll owe capital gains tax on the gains beyond the excluded amount. Like income tax, the capital gains tax rate is dependent on her taxable income from sources like work, investments or Social Security benefits. This tax rate is almost always lower than the rate that applies to other income, which makes it easier to build wealth through investments and assets than through working. Capital gains tax rates as of 2023 are:

  • 0% if her taxable income is less than or equal to $41,675 (if filing single).
  • 15% if her taxable income is between $41,675 and $459,750.
  • 20% if her taxable income is higher than $459,750.

With this information, you can help your mother prepare for a tax bill before selling the house, so it doesn’t create a burden. Capital gains are taxed in the year they’re received. So if your mother sells the house in 2024, they’ll be included in her 2024 tax return, and she’ll likely owe the tax payment by April 2025. She could:

You can learn more about payment plans at irs.gov/payments.

Dana Miranda is a Certified Educator in Personal Finance®, author, speaker and personal finance journalist. She writes Healthy Rich, a newsletter about how capitalism impacts the ways we think, teach and talk about money.


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