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If a homeowner's principal residence is sold, what is included in the calculation of the capital gain?

  1. The original purchase price only

  2. The sale price minus the closing costs

  3. The cost of home improvements

  4. Both the sale price minus the original purchase price and the cost of improvements

The correct answer is: Both the sale price minus the original purchase price and the cost of improvements

When calculating the capital gain from the sale of a homeowner's principal residence, it is necessary to consider the sale price, the original purchase price, and any capital improvements made to the property. The capital gain is determined by subtracting the adjusted basis (the original purchase price adjusted for improvements and certain other factors) from the sale price. In this context, the original purchase price provides the starting point for determining how much was initially invested. However, simply using the original purchase price does not capture all the investments made over the period of ownership. Any improvements that add value to the home and extend its useful life can be added to the original purchase price, thus increasing the adjusted basis. Therefore, the capital gain calculation should reflect the total amount received from the sale, minus the total investment made, which includes both the original purchase price and the cost of any improvements made to the residence. This comprehensive approach ensures a more accurate representation of the financial gain from the sale, as it accounts for all value-enhancing investments.