Realtor.com/Getty Images
The road to homeownership remains challenging, as inflation, mortgage rates, and home prices are all still high.
The median existing-home price in June was up 2% from one year ago, reaching $435,300, “a record high for the month of June, and the 24th consecutive month of year-over-year price increases,” according to the National Association of Realtors®.
In addition, the 30-year fixed mortgage for the week ending July 17 stood at 6.75%, according to Freddie Mac. For the corresponding weeks in 2022 and 2020, it stood at 5.51% and 2.88%, respectively, according to Freddie Mac data.
Because of this, more than ever, buyers are looking for mortgage co-signers—a route that can usually help get a loan faster and more easily.
But having a co-signer or co-owning a home for nonmarried people can become tricky when it’s time to sell. While many people sign on to mortgages to help others—like parents for kids or siblings helping siblings—they also sometimes don’t understand the tax implications if the home appreciates.
“Home prices have appreciated so much in recent years that many people are passing that exclusion threshold without realizing it. Combine that with fewer people upgrading or moving often, and you get a situation where longtime owners are now sitting on more taxable gains than they expected,” says Steve Sexton, CEO of Sexton Advisory Group.
That’s why it’s essential to do a proactive review before you sell: A simple conversation with your real estate adviser or tax professional could make a big difference in what you owe in capital gains.
Why more Americans could soon face capital gains taxes when they sell a home
The Internal Revenue Service has a “$250,000/$500,000 home sale tax exclusion.”
This means that if you have a capital gain from the sale of your home, “you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse,” according to the IRS.
The issue is that appreciation of homes has skyrocketed in recent years. Today, roughly 1 in 3 homeowners—nearly 29 million households—have built up more home equity than the federal capital gains tax exclusion for single filers protects when they sell their primary home, according to a recent analysis by NAR. By 2030, that number is expected to grow to 56% of homeowners.
That’s why U.S. Rep. Marjorie Taylor Greene (R-Georgia) recently introduced the No Tax on Home Sales Act. This bill would eliminate the federal capital gains tax on the sale of a primary residence.
“Families who work hard, build equity, and sell their homes should not be punished with massive tax bills,” Greene said in a press release. “The capital gains tax on home sales is an outdated, unfair burden—especially in today’s housing market, where values have skyrocketed. My bill fixes that.”
She noted that the $250,000/$500,000 exclusion was implemented in 1997 and has never been indexed for inflation.
“If it had merely been indexed for inflation when originally enacted, those exclusions would be more than twice as large as they are today ($506,000 and $1.13 million),” says Realtor.com® Chief Economist Danielle Hale. “And home price increases have outpaced inflation in many of those years, further eroding the value of the exclusions.”
What happens when co-owners sell and owe capital gains
When it’s time to sell the home, ownership structure matters. Being on the title means ownership, and thus is subject to gains/or exclusions. However, being on the mortgage alone does not give tax benefits or ownership interest.
As Sergio Altomare, co-founder and CEO of Hearthfire Holdings, a real estate private equity and development company, puts it, the IRS taxes ownership interest, not mortgage responsibility.
“The person on the title is the one who realizes the gain and is responsible for the taxes, not necessarily the one making mortgage payments,” he explains.
Then, each co-owner gets their $250,000 capital gains exclusion, providing that they meet the ownership use test, which is that they have owned and lived in the home for at least two of the past five years, he adds.
So, for instance, if one owner never lived in the home, they do not qualify for the exclusion, even if they help pay the mortgage.
“If there are three or four co-owners, the tax exclusion is per eligible individual, not split, as long as each person meets the residency requirement,” he says.
Practical strategies
This is why understanding the ramifications of co-signing a mortgage is crucial. Structuring co-ownership carefully from the beginning is key to avoiding potential headaches when you sell.
“People often enter co-ownership casually, but the IRS does not account for verbal or informal agreements when it comes to capital gains,” says Altomare. The structure of ownership—joint tenancy versus tenants in common—affects both tax treatment and how the gains are allocated.
He says clear documentation of ownership shares, occupancy, and contributions is essential to defending capital gains exclusion claims.
Sexton agrees, saying ownership structure should never be an afterthought.
“It should be part of the initial planning conversation before you close on the home,” he adds.
Plan ahead
Before buying a home with others, you should agree on ownership percentages, who will live there, and how proceeds will be split, Altomare says. Document this in a co-ownership agreement.
Consult with an attorney and tax specialists
This will help you to make sure that everything is clear.
“And then obviously, you should consult with tax professionals, which should be my disclaimer up front on this. Title is what matters far more than mortgage,” he says.
Consulting with a CPA tax adviser before a sale to determine each owner’s exposure and strategy to mitigate taxes could also help, he adds.
Keep records
Altomare says maintaining a clear paper trail (including who lived there and when), utility bills, tax filings, and lease agreements, especially if one co-owner rented it to another, is essential.
Sexton adds that documentation also includes your purchase paperwork, home improvement records, and anything proving you lived in the home. This entails utility bills, mail, and voter registration that can help support your exclusion claim.
“Real estate is one of the most powerful ways to build wealth, but only if you approach it with the right strategy and support,” he says.