Thinking of Selling Your Home?
Understanding the Home Gain Exclusion:
One of the largest tax breaks available to most individuals is the ability to exclude up to $250,000 ($500,000 married) in capital gains on the sale of your personal residence. Making the assumption that this gain exclusion will always keep you safe from tax can be a big mistake. Here is what you need to know.
The rule’s basics
As long as you own and live in your home for two of the five years before selling your home, you qualify for this capital gain tax exclusion. In tax-speak you need to pass three hurdles:
- Main home. This tax term defines what a main home is. It can be a traditional home, a condo, a houseboat, or mobile home. Main home also means the place of primary residence when you own two or more homes.
- Ownership test. You must own your home during two of the past five years.
- Residence test. You must live in the home for two of the past five years.
- You can pass the ownership test and the residence test at different times.
- You may only use the home gain exclusion once every two years.
- You and your spouse can be treated jointly OR separately depending on the circumstances.
When to pay attention
- You have been in your home for a long time. The longer you live in your home the more likely you will have a large capital gain. Long-time homeowners should check to see if they have a capital gains tax problem prior to selling their home.
- You have old home gain deferrals. Prior to the current rules, home-gains could be rolled into the next home purchased. These old deferred gains reduce the cost of your current home and can result in capital gain exposure.
- Two homes into one. Often newly married couples with two homes have potential tax liability as both individuals may pass the required tests on their own property but not on their new spouse’s property. Prior to selling these individual homes, you may wish to create a plan of action that reduces your tax exposure.
- Selling a home after divorce. Property transferred as a result of a divorce is not deemed a sale of your home. However, if the ex-spouse that retains the home later sells the home, it may have an impact on the amount of gain exemption available.
- You are helping an older family member. Special rules apply to the elderly who move out of a home and move into assisted living and nursing homes. Prior to selling property it is best to review options and their related tax implications.
- You do not meet the five-year rule. In some cases you may be eligible for a partial gain exclusion if you are required to move for work, disability, or unforeseen circumstances.
- Other situations. There are a number of other exceptions to the home gain exclusion rules. This includes foreclosure, debt forgiveness, inheritance, and partial ownership.
A final thought
The key to obtaining the full benefit of this tax exclusion is in retaining good records. You must be able to prove both the sales price of your home and the associated costs you are using to determine any gain on your property. Keep all sales records, purchase records, improvement costs, and other documents that support your home’s capital gain calculation.
If you are one of the unfortunate victims of IRS identity theft you will need a one-time PIN to file your tax return. Without this numeric identifier your 2015 tax return will be rejected. The IRS issues taxpayer victims this PIN in a written notice.
What has happened
IRS notices that have this one-time PIN are hitting mailboxes of identity theft victims right now. This is notice CP01A. The tax year printed on the notice may be 2014, when the PIN is to be used for your 2015 tax return. This mistake is causing confusion among taxpayers.
What to do
Do not throw out the notice! This PIN is for your 2015 tax return. Without it you cannot file this year’s tax return.
File your tax return. When tax return filing opens on January 19th, you can file your tax return. This PIN must be entered on your tax form to be accepted by the IRS.
The IRS knows of the mistake. They will not be issuing new forms. Here is their announcement on the error: https://www.irs.gov/Individuals/The-Identity-Protection-PIN-IP-PIN
For those who qualify, a married couple can exclude up to $500,000 ($250,000 for unmarried taxpayers) in capital gains from the sale of your principal residence. This exclusion can be taken once every two years as long as you meet a two-years out of five residency and ownership test before you sell the property.
What you need to know
Often tax planning is required to ensure you maximize this tax benefit. Here are some situations that require a review prior to selling your home.
Ownership and principal residency tests met using different years. As long as the two-year requirement is met for both tests you can take the deduction. It does not matter that you use different years for each test. The most common example of this occurs when you rent a home or condo and then buy it later.
Life events complicate things. Marriage, divorce, and death are common life-events that require planning to maximize the gain exclusion tax benefit. For example, you can take advantage of the full $500,000 gain exclusion after the death of a spouse, but usually only during the time you are able to file a joint tax return.
Selling a second home requires planning. While you can use the gain exclusion every two years, you need to be careful with a second home. You may be able to plan your living arrangements to make each home a primary residence during different tax years to meet the two-year requirement for both properties. This means you need to determine your primary residence each year with good recordkeeping in case you are audited.
Business use of your home. You will need to adjust your home basis (cost) for any business activity and depreciation of your home. This can create a depreciation recapture tax event when you sell your home.
A Partial gain exemption is possible. There are exceptions to the two-year tests when certain events occur. The normal exceptions include a required move for work, health reasons, or unforeseen circumstances. Since the IRS definition of each is vague, you should review your options if you are required to move.
Recordkeeping matters. Be prepared to document the gain on your property and how you meet the residency and ownership tests. Please keep all documents relating to the purchase and sale of your property. Save any receipts that document improvements to your home. Also keep an accurate record to support your claim of principal residence if you own a second home.
Given the potential for tax savings, please ask for help before selling your home or vacation property.
Sometimes tax laws create a natural conflict of interest among taxpayers. Establishing property values in an estate after someone dies is an area that creates this conflict. A new tax law is now in place to address this problem. Here is what you need to know.
Estate goal: Value property as low as possible.
Estates want to value property as low as possible to lower possible estate taxes.
Beneficiary goal: Value the property at time of receipt as high as possible.
Those who inherit property want their inheritance valued as high as possible, since there is no federal inheritance tax. If property is later sold, the taxable amount is only the amount received in excess of the value of the property on the date* it was received.
The IRS’ problem: A single piece of property is often incorrectly given two values at a single moment in time. One value given by the estate and a second, higher one, by the beneficiary to help when the property is later sold.
An example of the problem. A collector of old cars passes away. The estate values a specific antique vehicle at $75,000 on the date of death. A son of the person who died inherits the car. The son sells the car for $125,000, but has an appraisal of the car that says the car’s market value is $110,000. Since the son receives a “stepped up basis” to the fair market value at the date of death*, he uses $110,000 to calculate a taxable gain of $15,000 ($125,000 sales price minus $110,000 appraisal.) As a result of this transaction the IRS receives estate taxes based on $75,000, versus $110,000. The IRS only receives capital gain taxes on a $15,000 gain versus $50,000 ($125,000 minus $75,000.)
New Reporting Requirement
The solution. Get rid of the possibility to have two different values assigned to the same piece of property at a given moment in time.
The process. IRS now requires a statement of value for assets transferred through an estate. That value must be reported to them and to the person that receives the property from the estate.
Timing. This new reporting applies to all estates filing tax returns after July 31, 2015. The statement of value must be provided to the IRS and the beneficiaries within 30 days after either the due date of the return or after filing the return, whichever is earlier.
Comments. Since the details of how to report these transactions is still being established by the IRS, any estate subject to this reporting before February 29, 2016 has until February 29, 2016 to furnish the statement.
What’s the big deal?
The reporting requirement is mainly going to impact large estates, so why should you care? The new reporting requirement impacts both estates AND those that receive benefits from an estate. You could be impacted by simply receiving a small part of someone else’s estate. If this happens, you will need to look for the new statement of value.
* stepped up basis rules define alternative ways to determine the value of property transferred by the estate.
One of the biggest contributions a taxpayer can make is to donate a used automobile. But if not careful, the value of a donated vehicle could be a lot lower than you think.
When you donate a vehicle, the value of your donation is either the fair market value of your vehicle when you donate it OR the value received by the charitable organization for your donation. Unfortunately, you do not choose the value of the donated vehicle.
- If the organization uses the vehicle, or is in the business of using your vehicle to train others, you can deduct the fair market value of the vehicle.
- If the charitable group simply resells your donated vehicle, your donation is limited to what the organization receives for your vehicle and NOT the usually much higher fair market value of the item.
What you should do
Select the organization wisely. Select an organization that will either use the vehicle themselves or will use it to train others. Examples of qualified organizations include groups that help single mothers obtain transportation to and from work or use the vehicles to deliver meals to seniors. Other organizations teach auto repair and body shop work to the unemployed. The cars then are given to other non-profits or needy folks. From the IRS perspective, a qualifying charitable use either;
- makes significant intervening use of the vehicle or,
- makes significant improvement to the vehicle that increases its value or,
- donates the vehicle (or sells it at a below market rate) to a needy person that helps further the cause of the organization.
Research the fair market value. Prior to donating your vehicle go to a reputable source and estimate the value of your vehicle. Online resources like Edmunds.com and kbb.com (Kelley Blue Book) are two reliable sites to do this. Also make a copy of your title and take pictures of your car prior to donating it to the charity to help support your fair market value claim.
Obtain the proper tax form. When donating your vehicle make sure the organization gives you a proper Form 1098-C at the time you provide your vehicle. Double check the value assigned to your donation form to ensure it meets or exceeds the estimated fair market value of your donation. Remember, if your valuation exceeds $5,000 you will need an approved appraisal.
Sell the vehicle and donate the cash. If you cannot find a charitable organization that will allow you to maximize your fair market value deduction, consider selling the vehicle and then donating the proceeds. There is a potential problem with this approach,
however. Take care that you do not create an unplanned taxable capital gain with the transaction.
Note: These rules apply to other vehicle donations as well. This includes motorcycles, trucks, vans, buses, RV’s and other transportation vehicles.