Your mother always told you, “You will need math someday!” Well, that “someday” has arrived! You’re thinking of selling your house for $400,000 and you paid $300,000 when you bought it, so you are tempted to spend that $100,000 profit in your fantasies, but wait! There are things to consider and take into account before you count your chickens. Not all of them will hatch.
If we disregard the monthly payments and interest as roughly comparable to what you might have laid out on rent in that same time period, we are still left with factors to consider. There will be costs involved in your sale and closing as well as whatever cash you may have invested in the home while you were the owner.
Most people sign up with a real estate agent and agree to an entire commission of six or seven percent, to be shared among all agents involved in your sale. For our purposes we will use seven percent. This is justified as many strongly believe that by offering less, such as six percent, that you will probably be on the market longer and not have quite as easy a time in selling, eliminating any benefit or savings by skimping on the one percent.
The next part in determining costs can be tricky because what the seller pays and what the buyer pays in a residential real estate transaction varies according to the type of financing involved and the location of the house. In different geographic regions there are different customs as to what parts of the closing buyer and seller typically shoulder.
This is, however, all negotiable for the most part, unless there are costs that the lender simply won’t allow the buyer to pay, or to have paid by someone on the buyer’s behalf. In a typical closing, the lender has that kind of power because they have the ability to withhold funding if their own lending criteria are not adhered to.
The costs and pro-rations will also vary depending on the day of your closing. For example, if the property taxes happen to be $1,200 a year ($100 per month), and you close on July 1st (as we will in our example), each buyer and seller will be responsible for half of the year’s taxes, or $600 each. The Buyer’s taxes are often collected in advance and held in escrow by the lender so when the bill is due the money is already there, which protects the bank, and they therefore require such a practice.
So let’s use a rather common scenario as far as the lending situation and customary costs, and let’s assume our property is for sale in Florida. If you would like a more precise calculation of your own, there is a pretty good free closing cost calculator here.
The calculator you will find there offers buttons to select whether specific expenses are paid by the buyer, seller, shared, or “POC,” which means paid-out-of-closing. For example, most buyers must pay their appraiser his or her $300 or $400 fee in cash when the appraisal is performed. Appraisers used to simply wait for the closing to be paid but getting burned on too many deals that fell through has them generally wanting cash up front.
The calculator mentioned offers a very thorough rendering of what you might expect from a sale of your home for $400,000, paying customary fees and a sale date of July 1st. If you pay off a mortgage balance of $200,000, you would be presented with a check at the end of the closing for $166,725.
That means you had $33,275 in costs!
- $28,000 in real estate commissions,
- $400 settlement fee, which pays the title company or lawyer for handling the closing,
- $2,075 in title insurance typically paid by the seller in Florida and based on the sale price,
- And $2,800 in deed stamps, which is a tax collected by the state for the recording of your sale.
Where’s My Money?
So even after an equity gain of $100,000 (remember the value went from $300,000 to $400,000 while you owned it) after costs you are left with only a $66,725 long-term capital gain so far if you held the home longer than one year. That other $100,000 in your check is a recoup of cash you put down when you bought the home and the equity you created by making payments.
But notice we said so far in the previous paragraph. Let’s say part of the reason your value went up by $100,000 is because you invested $25,000 in a complete kitchen remodel and update. After you factor that investment in, your gain is even less: only $41,725.
Under the current US IRS tax code each spouse can realize $250,000 in gain from the sale of a personal residence without paying taxes, but be sure to verify this with your accountant. Other tax situations can have a major impact on your sale and be a large factor in your decision to sell or hold.
The point is not necessarily the specifics of the figures used here, but a primer of what to generally expect when selling. Your biggest expense in this scenario was the real estate commission. Lots of people try to skimp by offering less or sell on their own, but this is not necessarily advisable either, even from a strict financial analysis. Without professional guidance there is the possibility of taking much longer to find a buyer, encountering many more pitfalls, and additional liabilities even after a sale.
Your home can be a great investment – one of the best, in fact, but be sure to consider the costs of a sale, tax consequences, and alternative options such as renting before taking the plunge.