| TAX CONSIDERATIONS WHEN SELLING YOUR HOME
Q. Do I have to pay federal taxes on the sale of my home?
A. You do only if the profit on the sale is more than $250,000
($500,000 for a couple.)
Q. How do I determine my profits?
A. You can calculate your profits by subtracting the adjusted
cost basis of your home from its
adjusted sales price. You can compute the adjusted cost basis by subtracting
certain items such as the sales commission, lawyer's fees, and fix-up
expenses from the price of your home when you bought it.
To calculate the adjusted sales price, start with the selling price. Then
subtract the cost of
capital improvements made while you owned the home and closing costs not
deducted when you bought it. Note that you may not subtract the cost of
repairs. The IRS is very strict about what it considers improvements.
For example, repairing a water heater is not considered an improvement
but adding a dishwasher is. Also, you may deduct the labor costs paid
to a tradesperson (such as a carpenter) but not any costs for your own
labor. The IRS requires home sellers to complete a form in the year of
the sale that includes these calculations. You also will want to keep
all receipts for any costs you are deducting from the sale. Without such
written proof, the IRS is not likely to allow your deductions.
Q. Now I have figured my profits. What about figuring my taxes?
A. First, remember that if there is no profit, you do not have
to worry about paying taxes; however, the IRS does not allow you to deduct
any loss on a primary residence.
Until May 7, 1997, homeowners who sold their house could defer payment
of capital
gains tax by rolling the proceeds of the sale into a new house--but only
if the new house cost more than the old one did. Then, after age 55, when
they were probably in a lower tax bracket and ready for a smaller home
or retirement community, each person was entitled to exclude up to $125,000
in profit--but only once. Because of these rules, many families bought
bigger, more expensive houses than they needed, especially if they moved
to an area with lower real estate values.
All this changed in 1997 with a new tax law. Now, you don’t have
to pay capital gain on
the sale of any residence you’ve lived in for at least two of the
last five years, unless the profit is
more than $250,000 per person or $500,000 per couple. You have to count
not only the profit on this house but on any other houses you sheltered
by rollover prior to 1997. If special circumstances
meant you had to move before living there two years, you can exclude part
of the profit--for
instance, half the profit if you lived there only one year, up to your
$250,000 limit.
This change means that most people won’t have to pay capital gains
taxes at all on their
home, unless they’ve racked up enormous profit. And you can exclude
capital gain on sale of your residence as many times as you wish. Note
that this door doesn't swing both ways. If you lose money on the sale
of your home, you can't deduct the loss and pay less in taxes
The capital gains exclusion doesn’t apply to investment properties
and vacation homes.
However, people with more than one home can avoid tax on each of them
with a little planning.
For instance, if you have a condo in New York City and a house in Florida,
you could make the
New York home your primary residence for two years before selling it,
then make the one on
Florida your primary residence for two years before selling it. For a
house to count as your primary residence, you have to live there for 183
days each year.
Win or lose, whenever you sell a home you have to file Form 2119, reporting
the sale date,
the price and how much profit is subject to immediate taxation, if any.
This one-page form takes you through the calculations required to determine
gain on sale, adjusted sales price, and taxable gain. If you die without
selling the home, all capital gains taxes are wiped off the slate. Your
beneficiaries will inherit it at a new, stepped-up basis, and they don't
have to pay any tax on capital gains accumulated on the sale of your home
or homes over the years.
What if you own a duplex, live in one unit and rent out the other? In
that case, you can only
avoid capital gain on the half you use as your residence. The other is
a business property, not
subject to this tax break.
Save your receipts, because eventually your house just might gain enough
in value that
you’ll want to prove that your basis has increased and therefore
the profit isn’t as great as it
appears.
For details on IRS regulations in this area, see Publication 523, "Selling
Your Home."
Q. Will I owe state and local taxes on my profits?
A. It depends. You may live in a state or city that will require
you to pay state or local taxes on the
profits of a home. Some states or local communities also charge a "transfer
tax" on the sale of
property. This tax is usually levied as a percentage of the sales price.
Q. What is a sale-leaseback?
A. A sale-leaseback occurs when you agree to sell your home to
a buyer who agrees to rent the home to you for a certain period of time.
Usually, this type of arrangement occurs between retired parents and their
adult children. A sale-leaseback often provides the most advantages to
retirees in low tax brackets who have children in high tax brackets. The
family can structure it so that the children carry the burden of paying
interest and take the benefit of deducting the interest from their taxes.
The parents benefit by receiving income to offset expenses.
The sale-leaseback can be established in two ways. Either the buyer can
obtain a loan to
buy the home outright or the seller can provide some of the financing.
In the first case, the seller
would pay rent to the buyer. In the second case, the seller would pay
rent to the buyer while the buyer would make payments to the seller on
the loan given by the seller.
If you are considering this arrangement between relatives, be sure to
have your agreement
in writing and make sure that it conforms to IRS rules. For example, the
IRS requires that the
buyer pay a fair market price for the home and that the seller pay a fair
market rent in order for the arrangement to avoid qualifying as a gift.
In other words, the IRS will not permit you to structure a sale-leaseback
to lower your estate taxes. An attorney can help you draw up the necessary
papers to make sure you don't inadvertently run afoul of the IRS rules
and end up with a penalty or gift tax. See the chapter in this book on
older Americans for more on sales-leasebacks, reverse mortgages, gift
annuities, and other options of particular interest to older persons.
Gift Annuities
Q. How does a gift annuity work?
A. A homeowner interested in converting home equity into income
may want to consider a gift
annuity in which the homeowner donates the home to a qualified charitable
institution and is
eligible for a tax deduction against taxable income in the year in which
the donation is made. In
return, the institution provides an annuity to the donor and grants the
donor a life estate in the
home. This means that the donor may remain in the home for his or her
lifetime and is responsible
for all taxes and maintenance on the home. At the donor's death, the property
becomes the
possession of the charitable institution.
This arrangement offers several tax advantages, particularly for homeowners
who do not
have heirs or who want to reduce this size of their taxable estate. Again,
a financial professional or tax attorney should be consulted.
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