Too Much Equity?

Yes – it is possible to have too much equity.

One of the ways that the United States government incentivizes home ownership is by allowing a capital gains tax exclusion on the equity gained on a primary residence. Historically this meant that if you were a homeowner, you were pleasantly surprised when you went to sell your home to discover that you (usually) didn’t owe any taxes on the equity gained. Specifically, a single homeowner could exempt $250,000 in gain, and married couples could exempt $500,000 in gains. With typical appreciation at the time, it could take 10-15 years to reach these limits, so it’s not something that most homeowners – or even real estate agents – paid attention to. At an annualized average appreciation of 4% per year, it could take over 12 years on a $400,000 purchase to reach these limitations, and most people sell their residence within this time frame.

Until now. As affordability has become more of an issue, people are staying in their residences for longer. Additionally, the aggressive appreciation that we’ve experienced since the start of the pandemic means that the gains that used to take a decade to earn were accrued in a matter of years. A majority of homeowners aren’t paying attention to this, and rather than making moves to grow their money tax-free, most homeowners that have been in their home for 4 years or more may have a growing tax liability and not even be aware of it.

For example, Jesse bought his first home in 2003 in Everett, WA for $180,000. He sold that home in 2017 for $480,000. It took 14 years + rehab and renovation to get this appreciation. After renovation expenses and the cost of sale, Jesse sold almost exactly at a gain of $250,000 tax-free. Jesse then rolled that purchase into a Snohomish property that he bought for $670,000. In less than 4 years that property was worth $1,000,000, and he had fully exhausted the capital gains exemption on that property, meaning that any future gains would accrue at a taxable rate. Aware that he’s reached his limit, he could liquidate and sell, taking his tax-free gains and rolling that into the next primary residence, allowing that money to continue to grow tax-free.

Real estate has been the best vehicle to create wealth over the past hundred years, but how that wealth can be built has changed. If other factors aren’t more important (school district, proximity to work or amenities, etc), then the goal should be to get as close to the capital gains exclusion (without going over) as possible. If you are thinking of selling, but aren’t sure, knowing the tax basis of the equity in your primary residence can help. That’s where TooMuchEquity.com comes in!

Using the calculator below, you can enter your original acquisition cost, verifiable renovation costs, whether you are claiming a single or married exemption, and we’ll figure out the rest. We’ll send you a customized report that covers a general understanding of the equity in your home and a number of options to move forward, with recommendations to liquidate, hold or leverage your equity to limit your tax basis.

Knowledge is power – and knowing that you’re going to pay taxes on further appreciation might empower you to make a change and keep your equity growing tax-free!