Category Archives: Tax Tips

What You Need to Know When Selling Your Home

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The Internal Revenue Service has some important information to share with individuals who have sold or are about to sell their home. If you have a gain from the sale of your main home, you may qualify to exclude all or part of that gain from your income. Here are ten tips from the IRS to keep in mind when selling your home.

  1. In general, you are eligible to exclude the gain from income if you have owned and used your home as your main home for two years out of the five years prior to the date of its sale.
  2. If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).
  3. You are not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.
  4. If you can exclude all of the gain, you do not need to report the sale on your tax return.
  5. If you have a gain that cannot be excluded, it is taxable. You must report it on Form 1040, Schedule D, Capital Gains and Losses.
  6. You cannot deduct a loss from the sale of your main home.
  7. Worksheets are included in Publication 523, Selling Your Home, to help you figure the adjusted basis of the home you sold, the gain (or loss) on the sale, and the gain that you can exclude.
  8. If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.
  9. If you received the first-time homebuyer credit and within 36 months of the date of purchase, the property is no longer used as your principal residence, you are required to repay the credit. Repayment of the full credit is due with the income tax return for the year the home ceased to be your principal residence, using Form 5405, First-Time Homebuyer Credit and Repayment of the Credit. The full amount of the credit is reflected as additional tax on that year’s tax return.
  10. When you move, be sure to update your address with the IRS and the U.S. Postal Service to ensure you receive refunds or correspondence from the IRS. Use Form 8822, Change of Address, to notify the IRS of your address change.
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Medicare Tax on Home Sale

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Contrary to reports and newspaper articles circulating widely on the Internet, there is not a 4.0% “sales tax” or “transfer tax” on the sale of a home included in the health care reform bill signed last year. The analysis underlying these reports is incorrect and fails to take into account the interplay of the bill’s provisions with already existing real estate tax laws that remain unchanged.

What was included in the health bill is a provision that imposes a new 3.8% Medicare tax for some high income households that have “net investment income.” Any revenue collected by the tax is dedicated to the Medicare hospital insurance program. This new tax will only apply to households with Adjusted Gross Income (AGI) of more than $200,000 for individuals or more than $250,000 for married couples. Since capital gains are included in the definition of net investment income, an additional tax obligation might result from the sale of real property.

In the case of the sale of a principal residence, the existing $250,000/$500,000 exclusion from capital gains on the sale of a principal residence remains unchanged. Consequently, even when the AGI limits are met, the new tax would not be applied to all capital gains that result from the sale of a home. Rather, it would only apply to any home sale gain realized in excess of the $250K/$500K existing primary home exclusion that pushes the filer’s AGI over the $200K/$250K adjusted gross income limit.

The new Medicare tax will not take effect until January 1, 2013.

If you have a client in need of assistance preparing their tax returns or facing an IRS audit, I would be happy to assist them.  Feel free to refer them to me using the information below.

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Basis of Rental Property vs. Fair Market Value

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It is not uncommon for homeowners to consider converting their current home to rental property when purchasing a new home.  The reasons are varied, such as hoping for a better sales price by holding on to the property for a few years, or the existence of a strong rental market and a desire for an income stream as well as tax savings derived from allowable depreciation and other deductions associated with ownership of investment property.  Sometimes, homeowners will rent their residence as the result of temporary employment relocation, with the expectation of returning in only a couple of years.

For tax purposes, the converted residence becomes depreciable as rental property when it is placed in service, meaning the date it is ready and available for rent.  Depreciation is based on the useful life of the asset from the date placed in service until it is retired from service (for example, you move back into the residence.)  The useful life for residential rental property (and any improvements) is 27.5 years using the straight-line method.

Generally, the basis of the property for depreciation is your original purchase price including most of the settlement charges on the HUD closing statement plus the cost of any capital improvements (not repairs) made up through the “placed in service” date minus the value of the land.  For example, you purchased the home in 1998 for $320,000, incurring capitalized settlement costs of $7,500, replaced the roof for $4,000 and refurbished the kitchen for $30,000 resulting in an adjusted basis of $361,500.  You rent the house out in 2011 at a time when the fair market value is $450,000.  If we assume the portion of the purchase price for the land was 20%, or $64,000, the depreciable basis is $297,500.

Sounds great, right?  But what if your rental property is in a part of the country where residential real estate prices have taken a severe nose dive from the economy the past few years and comparable values for houses similar to yours are selling for $250,000.  Do you still get to depreciate your adjusted basis?

Not according to Internal Revenue Code sections 167 and 168.  These sections say that you must use the lower of the fair market value at the time the rental property is placed in service or the adjusted basis.  Under this rule, and using the example above, the basis for depreciating the building would be $200,000.

If you’ve recently converted a residence to rental property, please review your tax records to make sure the transaction was properly handled.  If you or a friend is in need of assistance preparing your tax returns or facing an IRS audit, I would be happy to assist them.  Feel free to refer them to me using the information below.

 

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