Craft Your Financial Legacy with Real Estate

For longtime homeowners in Bellingham and Whatcom County — particularly those who bought their home in the 1990s or early 2000s — the single most significant financial question at the point of sale is usually some version of "how much of this is taxable?" Equity accumulated over twenty or thirty years in a Pacific Northwest market that has seen sustained appreciation can easily be several hundred thousand dollars, sometimes substantially more. That gain is not automatically tax-free, but most of it, for most homeowners, is. Understanding how that works — clearly, without the jargon, and with the specifics that actually matter — is one of the most valuable things a seller can do well before listing. The short version is that the federal tax code allows a homeowner to exclude up to $250,000 of capital gain from the sale of a primary residence if filing as a single taxpayer, or up to $500,000 if married filing jointly. Gains above those amounts are taxed as long-term capital gains at the applicable federal rate, with no Washington State income tax to add to the federal bill. The exclusion applies if the homeowner has owned and used the home as their primary residence for at least two of the last five years before the sale. That's the core rule. The nuance, and the places where longtime homeowners sometimes run into surprise, is in the edges of that rule rather than the center. What "capital gain" actually means for a home Capital gain, in the context of a home sale, is not the full sale price. It's the difference between what you sell the home for — net of selling costs — and what you paid for it, adjusted for certain improvements you've made over the years. The formal term for your adjusted purchase price is your "basis" or "cost basis." If you bought your home in 1998 for $180,000, added a $40,000 addition in 2006, and sell it in 2026 for $750,000 with $45,000 in selling costs, your gain is not $570,000. It's roughly $485,000 — the sale price minus the selling costs minus the original purchase price minus the improvement. This matters because $485,000 of gain for a married couple is fully within the $500,000 exclusion. Zero federal capital gains tax owed. For a single homeowner in the same situation, $485,000 of gain is $235,000 above the $250,000 exclusion, taxed at long-term capital gains rates — meaningful, but still dramatically less than the gross numbers would suggest. Getting the basis right is therefore one of the most underappreciated parts of preparing for a sale. Every significant improvement made over the years — additions, new roof, kitchen remodel, new windows, hardscaping, HVAC replacement — can add to basis if it's a true improvement rather than a repair. Repainting a wall doesn't add to basis. Replacing the whole roof does. For homeowners who have been in a home for a long time, reconstructing this history before sale can shift the tax picture by tens of thousands of dollars. The ownership and use tests The exclusion applies if you've owned and used the home as your primary residence for at least two years out of the last five years before sale. The two years don't have to be consecutive, and they don't have to be the most recent two. This matters for a few specific situations. A homeowner who moved out of their home and rented it for a year before selling can still claim the full exclusion, as long as they meet the two-out-of-five rule. A homeowner who owns two homes and is deciding which to sell may have flexibility around which qualifies as "primary" based on the facts of how the homes were used. A homeowner who converted a home from rental to primary residence (or vice versa) has a more complicated calculation that depends on the percentages of time in each use. For most Bellingham homeowners selling their long-term primary residence, the test is straightforwardly met and isn't something to worry about. But for homeowners with more complex property histories, the details matter and deserve specific attention. The frequency limitation A homeowner can only claim the full exclusion once every two years. This rarely affects retirees and longtime homeowners — most are selling a home they've been in for decades. But for sellers who have recently used the exclusion on a prior home (within the last twenty-four months), the exclusion may not be available for the current sale. Gains above the exclusion For longtime Bellingham homeowners with substantial equity, it's increasingly common for the taxable gain after the exclusion to be non-trivial. A married couple selling a home purchased thirty years ago with a current gain of $700,000 has $200,000 of gain above the exclusion, taxed at long-term capital gains rates. At the federal long-term capital gains rate applicable to many retirees (15% for the typical tier, 20% for the highest), that's $30,000–$40,000 of federal tax. Significant, but a much smaller bite than the same gain would produce if all of it were taxable. For single filers, or widowed spouses who have lost the joint filing eligibility, the math tightens quickly. A widowed spouse who sells within two years of the spouse's death can still use the $500,000 exclusion under a specific provision of the tax code. After that two-year window, only the $250,000 single-filer exclusion is available. This is one of the situations where timing, within a planning horizon, can make a meaningful financial difference. What increases and doesn't increase basis Improvements — substantial work that adds value, prolongs useful life, or adapts the property to new uses — add to basis. A new roof, a new furnace, an addition, a finished basement, a new deck, a new driveway, new windows, major plumbing replumbing, electrical panel upgrades, kitchen and bathroom remodels — all add to basis. Repairs and routine maintenance do not. Fixing a leaky faucet, repainting the exterior, replacing a few broken shingles, routine furnace service — these don't add to basis, even though they keep the home in good condition. The distinction between "improvement" and "repair" is sometimes fuzzy, and the IRS has guidance on it. Work that restores the home to its prior condition is usually a repair. Work that upgrades the home to a better condition is usually an improvement. Selling costs — the real estate commission, title and escrow fees, recording fees, and certain other closing costs — are subtracted from the sale price when calculating the gain, effectively reducing the taxable amount. This is why net proceeds matter more than gross sale price for tax purposes. Records matter more than people expect The single most common regret among longtime homeowners at the point of sale is not having records of improvements made over the years. Receipts from a 2004 kitchen remodel, invoices from a 2011 roof replacement, contractor records from a 2015 addition — these matter directly to the gain calculation, and reconstructing them after the fact can be time-consuming or impossible. If a sale is within a one to three year horizon, beginning to gather these records is one of the quieter but most valuable preparation tasks. Even approximate records supported by dated photos, canceled checks, or contractor names can help substantiate improvements on a tax return. The IRS generally accepts reasonable substantiation; it does not require perfection. Washington State specifics Washington does not have a state income tax, which means there is no state capital gains tax on the sale of a primary residence for the overwhelming majority of sellers. (Washington does have a capital gains tax on long-term gains from certain financial assets above a threshold, but that tax specifically excludes real estate sales.) Washington does have a real estate excise tax (REET) paid at the time of sale, which is effectively a transfer tax rather than an income tax. REET is paid out of the sale proceeds at closing and is separate from capital gains. For most Bellingham sellers, the tax analysis is therefore a federal-only analysis, which simplifies things considerably compared to states with income taxes stacked on top. What this actually means for planning For most longtime Bellingham homeowners selling a primary residence, the combination of the $250,000 / $500,000 exclusion, proper basis documentation, and the absence of state income tax means that the majority of the gain is likely to be tax-free, and the portion that is taxable is taxed at long-term capital gains rates rather than ordinary income rates. That's often a more favorable picture than sellers initially expect. The places where this can go sideways are: insufficient basis documentation that leaves money on the table; widowhood situations where the two-year window for the $500,000 exclusion has closed; rental-to-primary conversions that complicate the calculation; and sales within two years of a previous primary residence sale where the exclusion isn't available. Each of these deserves a specific conversation with a CPA or tax advisor in advance of listing. A quieter way to think about this The tax picture of a home sale is rarely as punishing as longtime homeowners fear. For a very large portion of Bellingham sellers, the exclusion covers the entire gain, and the sale is federally tax-free. For sellers with gains above the exclusion, the tax is real but manageable and usually represents a small percentage of the total equity being realized. The work worth doing in advance is gathering records, confirming the basis, and having a brief conversation with a tax professional to verify the specifics for your situation. That work produces a clear number rather than a vague worry, and a clear number is almost always easier to plan around. Frequently asked questions Do I owe capital gains tax if I reinvest the money into another home? Not because of the reinvestment itself. The old "rollover" rule that required buying another home to defer tax was replaced by the current exclusion system in 1997. The exclusion applies whether or not you buy another home. What about a 1031 exchange? A 1031 exchange applies only to investment property, not to a primary residence. For a home you've lived in as your primary residence, the exclusion is the applicable rule, not a 1031 exchange. Do I need to report the sale if the entire gain is excluded? Generally not, if you receive Form 1099-S from the closing agent and the entire gain qualifies for exclusion. If the gain exceeds the exclusion or if you don't meet the ownership and use tests, the sale must be reported. Your CPA can confirm which applies. How are selling costs handled? Commissions, closing costs paid by the seller, and certain other costs reduce the sale price for purposes of calculating the gain. They are not separately deductible; they're netted into the gain calculation. Related reading  *What Longtime Homeowners Often Get Wrong About Their Home's 'Basis'* goes deeper into basis calculation, and *How Long-Term Equity Changes the Math on Whether to Sell or Hold* addresses how the equity picture affects broader planning decisions.