# Do Closing Costs Reduce Capital Gains?

When it comes to tax implications, closing costs can potentially play a role in reducing capital gains. By including your closing costs into the cost basis of your property when it's sold, you essentially increase the initial investment amount. The effect of this is that it reduces the total profit or 'capital gain' realized from the sale. As a result, the potential capital gains tax that you may owe to the IRS could be lessened. Here’s how it works.

### What are Closing Costs?

Closing costs are expenses incurred on the transaction of a property. Both the seller and buyer pay these costs. Although the buyer typically pays less. Fees are generally between 6-10% for the seller and 2-5% for the buyer. The seller can deduct closing costs from the sale proceeds while the buyer has to pay them out of pocket.

There's no set price for closing costs. The total costs vary due to many factors, including state, home sale price, and the buyer's mortgage.

Closing costs are made up of the following, though this list is not all-inclusive:

• Realtor commissions
• Title fees
• Unpaid property taxes
• Outstanding HOA fees

Realtor commissions are by far the largest portion of closing costs for sellers. Negotiating on commissions can result in \$1000s saved on higher-priced homes.

### Including Closing Cost in the Sale of Property

Closing costs are added to the home’s adjusted cost basis. This increases the cost basis, closing the gap to the selling price and thus reducing overall profit. Because profit is reduced, so are capital gains. So yes, closing costs can reduce capital gains.

If the property is sold for a loss, closing costs can still be added to the basis. In this case, it will increase the amount of loss.

Here’s how the math works on adding closing costs to the sale of property:

Sale price: \$500,000

Total closing costs: \$45,000

New basis: \$395,000

Profit: \$500,000 - \$395,000 = \$105,000

Capital gains on this sale will be \$105,000, and taxes will be owed on this amount. You can see how adding the closing costs closed the gap to the sale price. Without the closing cost, taxable profits would have been \$150,000.

When selling a rental, investors must also be aware of depreciation recapture. Depreciation recapture can't be added to the cost basis and is a tax owed to the IRS. If the home is sold for a loss, no depreciation recapture expense exists. This depreciation recapture, like capital gains taxes, can be deferred using a 1031 exchange to dispose of the property.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.

Hypothetical examples shown are for illustrative purposes only.