$100,000 Profit?
Your mother always told you, “You will need math someday!” Well, that “someday” has arrived! You’re thinking about selling your house for $400,000, and you paid $300,000 for it, so you’re tempted to spend that $100,000 profit in your fantasies. But wait! There are a few things you need to consider before you start counting your chickens—because not all of them will hatch.
If we disregard the monthly payments and interest, assuming they are roughly comparable to what you might have paid in rent during that time, we are still left with a few important factors to consider. There will be costs involved in the sale and closing, as well as any cash you may have invested in the home during your ownership.
Costs
Most people hire a real estate agent and agree to a commission of 6-7%, which is shared among all agents involved in the sale. For our purposes, we’ll assume the commission is 7%. This is often justified by the belief that offering a lower commission (such as 6%) might result in a longer time on the market and a more difficult selling process—ultimately eliminating any benefit or savings from reducing the commission by just 1%.
Determining who pays for what in a residential real estate transaction can be tricky, as it depends on the type of financing and the location of the property. Different regions have varying customs regarding who typically covers certain costs at closing.
The Bank
However, most of these costs are negotiable, unless there are specific charges the lender will not allow the buyer to pay, or have paid on their behalf. In a typical closing, the lender has this kind of power because they can withhold funding if their own lending criteria are not met.
The costs and prorations will also vary depending on the day of closing. For example, let’s say the property taxes are $1,200 per year ($100 per month), and you close on July 1st (as we’ll do in this example). Both the buyer and seller will be responsible for half of the year’s taxes, or $600 each. Buyers’ taxes are often collected in advance and held in escrow by the lender so that when the bill is due, the money is already set aside. This protects the bank, which is why they require it.
Example
Let’s assume a typical scenario for the lending situation and customary costs in Florida. If you’d like a more precise calculation, there’s a helpful, free closing cost calculator here.
The calculator allows you to select whether specific expenses are paid by the buyer, seller, shared, or “POC” (paid-out-of-closing). For example, most buyers are required to pay the appraiser’s $300-$400 fee in cash when the appraisal is performed. Appraisers used to wait until closing to be paid, but after too many deals fell through, they now prefer cash up front.
The calculator provides a detailed breakdown of what you might expect from a sale of your home for $400,000, paying customary fees, with a closing date of July 1st. If you have a mortgage balance of $200,000, you’d receive 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)
$2,800 in deed stamps (a tax collected by the state for recording your sale)
Where’s My Money?
Even after an equity gain of $100,000 (remember, the value went from $300,000 to $400,000 while you owned it), you’re left with only a $66,725 long-term capital gain if you held the home for longer than one year. The remaining $100,000 in your check is a recoup of cash you put down when you bought the home, along with the equity you built through your mortgage payments.
But notice we said “so far” in the previous paragraph. Let’s say part of the reason your home’s value increased by $100,000 is because you invested $25,000 in a complete kitchen remodel and update. After factoring in that investment, your gain is even less—only $41,725.
Tax-Free
Under the current U.S. IRS tax code, each spouse can realize up to $250,000 in gain from the sale of a personal residence without paying taxes. However, you should verify this with your accountant, as other tax factors may significantly affect your sale and could influence your decision to sell or hold.
The Point
The point here is not necessarily the specifics of the figures used, but rather to give you a general idea of what to expect when selling a home. Your biggest expense in this scenario was the real estate commission. Many people try to cut costs by offering a lower commission or even selling the home on their own, but this may not always be the best decision, even from a strict financial standpoint. Without professional guidance, you might face a much longer time on the market, encounter additional pitfalls, and face greater liabilities, even after the sale is complete.
Your home can be a great investment—one of the best, in fact. But before you make a decision, be sure to consider the costs of selling, the potential tax consequences, and alternative options such as renting.
