Taxes on home sale

Panama City, Florida
Buying & Selling Real Estate
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Taxes on home sale

Laurie Geissler
Member since 2023 · 2 posts · 1 vote

I am looking for advice. I bought a 2/2 home and converted the detached garage into a 1/1 home. Myself and the other owner have discussed selling the property instead of renting it out. We did live in the 2/2 for a year and a half as a primary residence but bought another home with the plan to rent our the 2/2 and 1/1. I understand that we do not meet the 2 of 5 rule for the 250k tax exemption. However because we have held this property for over a year or is my understanding that we would pay long term capital gains. My question is can the capital improvements be added to the cost basis in order to reduce the long term gain. Am I correct in my thinking? I have been told different things by different CPA's and at this point I'm concerned about my knowledge and the conflicting information. We would rather keep it as two rentals if we are going to owe a lot in capital gains as it wouldn't be worth it. Any time input would be appreciated.

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  • Ryan SpathBusiness Member
    Real Estate Agent · Boise, ID · Member since 2017 · 598 posts · 382 votes
    1y

    Disclaimer: I am not a CPA and do not claim to be one. Always seek professional advice when it comes to tax and or legal matters. However, based on my understanding, the following applies:

    ✅ 1. Long-Term Capital Gains

    Since you’ve owned the property for over a year, and you're not meeting the "2 out of 5 years" requirement for the Section 121 exclusion ($250k per person or $500k for married couples), you will likely owe long-term capital gains tax on the sale profit.

    ✅ 2. Adjusted Cost Basis

    To calculate your taxable gain, you'll subtract your adjusted cost basis from the sale price.

    Your adjusted cost basis includes:

    • Original purchase price
    • Capital improvements (not repairs)
    • Closing costs (some may be added to basis)
    • Depreciation (if any, this gets subtracted if you depreciated the property while renting)

    💡 What Qualifies as Capital Improvements?

    Capital improvements are permanent enhancements that add value to the property, prolong its life, or adapt it to new uses. From your description, these may include:

    • Garage conversion to a 1/1 unit: This is a big one. As long as the work was permitted and done to code, it can be added to your cost basis.
    • Any structural upgrades, HVAC, electrical, plumbing, roofing, etc.

    Make sure you have receipts, invoices, and documentation for all improvements.

    ⚠️ Other Tax Considerations:

    • If you depreciated the property while renting it, you’ll need to recapture depreciation, which is taxed at 25%.
    • Split ownership: If you co-own the property with someone else, each person reports their share (typically 50/50 unless otherwise specified).
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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
    1y

    @Laurie Geissler Yes, you’re correct, capital improvements such as converting the garage into a 1/1 unit can be added to your cost basis, which helps reduce the taxable long-term capital gain when you sell the property. Since you didn’t live in the home for 2 of the past 5 years, you don’t qualify for the $250K/$500K capital gains exclusion, but because you've owned it for over a year, any gain will be taxed at the long-term capital gains rate (typically 15–20% federally, plus state income tax).

    Additionally, if you have claimed or were eligible to claim depreciation for the rental portion, you’ll owe 25% depreciation recapture tax on that amount. If the resulting tax liability significantly reduces your net proceeds, it may be smarter to hold the property as two rentals, benefit from ongoing cash flow, continued depreciation deductions, and possibly use a 1031 exchange in the future to defer capital gains tax entirely. A qualified real estate CPA can help you calculate your exact tax exposure and make an informed decision.

    This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

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