When Geoffrey Barrett inherited a 1942 brick duplex from a relative, it was a diamond in the rough. Diamond because of its location in convenient, in-demand suburban Arlington, Virginia. Rough because of its deteriorated condition.
Barrett wanted to bring back the shine and sell the property quickly for top dollar. As a mortgage finance professional, he says, he knew that achieving the most bang for the buck meant making only the right improvements to the house and spending enough — but no more — on the work. That is, “not over-improving it,” he says.
Spoiler alert: He did it. Barrett’s relative bought the 1,140-square-foot house for $159,000 in 2000. When Barrett became owner in fall 2017, the cost basis (the value assigned to the property for tax purposes) had risen to $400,000. Over about six weeks Barrett invested $65,000 on fix-ups to make the house appealing to buyers, and that increased the cost basis to $465,000. Listed at an attractive price of $515,000 in November 2017, the house drew many offers and sold for $520,000 in December 2017. After subtracting costs and accounting for the stepped-up value, Barrett realized a profit of about $90,000. But subtracting the $65,000 in presale improvements yielded a taxable capital gain of just $25,000.
Reaching such a happy ending when selling a house is not just good luck. It involves careful planning and control, and a team of well-chosen experts.
Knowing some of the rules of how to upgrade and sell a home for a profit is especially important now that the market is in turmoil due to the coronavirus pandemic.
Agent as adviser
Step one is choosing the right real estate agent. Andrew Schroeder, chief executive of Fairfax, Virginia-based Schroeder Design Build, a remodeling company that also buys, improves and sells homes, says: “The appropriate agent knows your area, your buyer, your exact market.” That knowledge informs all the decisions as the house is prepared for sale.
Real estate agent Lenore Rubino of Washington Fine Properties in Washington, D.C., says that “while a good agent can turn around a house quickly for market, optimally owners should come to us a year or six months ahead” of a planned home sale, so she and Washington Fine Properties agent Karen Nicholson can help the owners identify necessary repairs, and choose improvements that will add sales appeal and boost the asking price — as well as recommend contractors who can do the work well, cost-effectively and on schedule.
Barrett says he turned to Morrison because she specializes in Arlington neighborhoods. Morrison recommended specific changes to make to the house, whom to hire for the work and what selling price to ask. She also helped Barrett decide whether to consider an offer to buy the house as-is for $325,000 before it was listed. She advised against it, as a fixed-up house could command a higher sales price and better profit. (As Barrett points out, since the $25,000 taxable profit is based on the $400,000 stepped-up value rather than what was offered for the unrenovated property, “the real profit was actually $75,000 higher than that $25,000 — when you account for the difference between $400,000 and $325,000.”)
Morrison says the three-bedroom, two-bath house was dilapidated but had a lot to offer, including a main-level master bedroom and bath in a rear addition, a finished basement, “a great location, a yard, a driveway and hardwood floors.”
“For top dollar, you want to show that the house has been cared for,” Rubino says. It should be as clean and pristine as possible. On Morrison’s recommendation, Barrett refinished the floors, replaced the carpeting, repainted the entire interior, made simple improvements to the second-floor bathroom, and added new carpeting and recessed lighting in the basement.
Nicholson says a good exterior presentation is key. Sellers will get “a 100% rate of return,” she says, on what they spend on “a painted front door, good hardware, clean windows and a mowed lawn.” Morrison found that the roof looked brand new and needed no attention. But she advised Barrett to paint the entry door, deck and shutters, repair and paint the windows, replace the side deck stairs with smaller ones designed to preserve more patio space, and tidy up the yard.
Focus on the kitchen and baths
Morrison advised Barrett to spend most of his $65,000 fix-up budget on modernizing the drab and dated kitchen and bathrooms. Bright, new-looking kitchens and master baths can be buyer magnets. Smart updates to these rooms are likely to yield a healthy return on investment, by raising the asking price and reducing the time to find a buyer, thus shaving the seller’s ownership costs.
The first rule of presale home improvements, says Schroeder, is to do “the minimal amount that it would take to make the buyer want the home. Make a list of changes that will maximize the return.”
The second rule? Create a clean, new look but keep it neutral. As Rubino says, sellers need to keep their personal taste out of the picture. Instead, they should aim for an environment with broad appeal, where many buyers could see themselves living.
Like many real estate agents, Morrison has a go-to contractor who is seasoned in making presale improvements. She told the contractor how she wanted the kitchen and baths to look, and he gave Barrett several options at different price points to achieve that effect within the six-week time frame. Barrett hired painting and flooring contractors directly.
For most presale kitchen upgrades these days, white is right. Barrett transformed the kitchen with new, stainless steel appliances, granite counters, cabinets, brushed-chrome hardware and a stylish undermount sink and faucet combo. Freshly painted white trim added a nice pop against a soft gray wall color. Recessed ceiling lights and large ceramic floor tiles in a light shade completed the bright new kitchen.
Schroeder agrees that kitchens and baths must be spiffed up before listing a home for sale, but he says one bathroom — the master bath — takes priority over other bathrooms. “You can add nicer countertops and a custom vanity in a basement bath,” for instance, “but that’s not going to matter much to the buyer or be reflected in a higher offer price,” he says.
Barrett dramatically improved the master bathroom by replacing the old tub with a walk-in shower wrapped in a classy ceramic-tile surround. He swapped the dingy vanity for a new one featuring white cabinetry, a granite top and a white sink with brushed chrome faucet. A white-framed mirror, vanity light fixture, new commode and ceramic-tile floor make the room look entirely new. More limited changes in the second bathroom, including a glossy white tub surround, new vanity knobs and the removal of a cabinet behind the toilet, make that room feel clean and uncluttered.
Clearing and staging
During Washington state’s stay-at-home order, home sales are allowed with limited property viewings.
“Most buyer’s agents are showing vacant homes and using hand sanitizer/wipes upon entering and exiting the home,” Morrison said about her region. “Occupied homes have different protocols based on the homeowners’ desires.”
Barrett prepared his home before the pandemic hit. He paid Washington, D.C., company Nova Junk $1,600 to clear everything out of the house, including furniture and accumulated clutter. Co-owner Norman Eldekri says the full-service junk removal company can remove single items, or send in a crew to empty an entire house over a number of hours; the fee is based on the space filled in the company’s trucks. The company takes some things to donation or recycling centers and disposes of others.
Once the house was empty, Morrison paid a professional stager to lightly furnish and accessorize it. As with construction contractors, many real estate agents have stagers, plus professionals they use regularly to help with the decluttering and moving process. The agents may cover the cost of staging or share it with the seller because they see the important role of staging in realizing a quick sale at the best price, says Shean Atkins, of District Home Staging in Washington, D.C. Generally, the staging budget may be up to 1% of the listing price.
Markovist Wells, also of District Home Staging, says a stager assesses the space and factors in the buyer profile, then recommends which items to keep, which to remove (owners choose whether to store or discard them), and which items to add from the stager’s inventory.
Alex Williams, the third partner of District Home Staging, says the stager brings in and arranges furniture and accessories, typically as a two-month rental, with monthly extensions if needed.
Because the rooms in Barrett’s house are small, Morrison’s stager chose small-scale furnishings that would not overpower the space. She created an entry area using a furniture arrangement, and an inviting sitting area in the living room. She was able to place a small table and chairs in the kitchen to provide the all-important eating and gathering center.
Not every room needs to be staged. “The staples are the living room, kitchen and master bedroom,” Atkins says. Morrison’s stager furnished the original, second-floor master bedroom as such, and she gave the first-floor master bedroom a more versatile treatment so that buyers could envision it as a family room, office or guest room.
“Ancillary bedrooms, smaller or odd-shaped rooms might be staged minimally to suggest how they could be used,” Atkins says. In some rooms, a queen-size bed and an 8-by-10 rug, for example, might be all that’s needed to demonstrate the room size. Nicholson says even simple touches such as white, fluffy towels, bright lightbulbs, professionally cleaned windows and raised blinds can make a big difference.
The aim is for home shoppers to “see themselves living there,” says Nicholson, and then step forward to make the home their own.
Watching the tax burden
A residential property may command a sales price considerably higher than what the owners paid, especially if they bought the place many years ago. While the profit, or capital gain, is welcome news for the seller, paying taxes on that gain is not.
The federal capital gain tax rate on the sale of a primary residence, says Chuck Wight, a certified public accountant with Wight & Walsh, Olney, Maryland, is currently up to 15 or 20 percent of the profit.
To avoid a big tax hit on the gain, sellers used to have to reinvest it without delay in another home. If they didn’t buy another home, they were stuck with the gain. That is not the case now. And the taxable capital gain on the sale of a primary residence — meaning a house the sellers have occupied full-time for at least two of the past five years — can be reduced in several ways.
First, $250,000 of the gain is tax free for the seller; this amount is per person, so for a couple, $500,000 of the gain is tax free. Second, the cost basis of the house — the dollar value assigned to the original price when calculating capital gain — can be increased to more than the purchase price itself. Original closing expenses, major improvements the owner made while living in the house (not general maintenance), the cost of fix-ups in the last 90 days before the property is listed for sale and the cost to carry and sell the property, all can be added to the tax basis of the house at the time of sale. In other words, the profit number, or taxable gain, may be reduced significantly.
Wight offers this advice to homeowners watching their taxes:
• Walk through the house and know what improvements you have made over the years.
• Keep receipts for major improvements and presale fix-ups. If receipts are lost, photos and cost estimates may be sufficient even in a tax audit.
• Though you may want your children to inherit your house after you die, don’t give it to them now. If you own the house when you pass away, the fair market value will be used as the tax basis (tax step-up), even if that value is much higher than what you paid for the house. But if you have given the house to your children, that step-up in tax basis will not occur when your beneficiaries sell, and the capital gain may be high.
• The same advice holds for joint owners, such as couples. It’s best to retain shared ownership. For example, when a husband dies, his share of the house gets a step-up in tax basis to fair market value. And when the wife sells the house, she still can exclude the first $250,000 of gain on her share. By applying these two factors, the capital gain may be reduced considerably.
• Bottom line? Wight says, “If you sell your house and there’s a capital gain, consult an experienced tax preparer for that tax year. They deal with this a lot.”