December 20, 2016
Welcome to the first (of many) issues of TAX BITES, our monthly newsletter designed to help you make smart tax decisions.
This month, we look at the tax implications of selling a home. Jackpot or pitfall? As with many things tax related, it depends! Read on for more.
Kathleen S. Vaccaro, EA
Goldberg & Vaccaro Tax Services LLC
I hit the jackpot in the in-law department. Martha and Ralph are kind and loving, without being intrusive. Over the years, they have racked up some impressive stats:
62 years of marriage
14 pets of various species and gender
54 years in the same house
President Eisenhower was in the White House when they bought the land on which they eventually built. I'm pretty sure they paid less than the cost of my new Honda CRV.
Now, at ages 86 and 97, they (or more likely she) decided it was time for a change... and fewer stairs. So they built a new house, and moved in... right next door to the old house, which they are now selling.
With four bedrooms, two baths, lots of land, and an easy walk to the Falmouth beaches, it won't stay long on the market.
So here comes the financial challenge: Their tax return will show a whopping capital gain!
Let's do the math. Original purchase price = Honda CRV. Current asking price = $470,000. Capital gain = at least $400,000.
Fortunately, and like many people in their situation, they will pay zero tax on that capital gain when they sell their longtime residence.
Why? Because IRS rules allow a married couple to exclude up to $500,000 capital gain from the sale of a personal residence. Single filers can exclude $250,000. (And you are eligible for the full exclusion as often as every two years.)
For most people, it's an easy equation with no tax due... except when it isn't.
Have you ever taken the home office deduction?
Have you ever rented out any part of your property?
The home sale exclusion only applies if you OWN and OCCUPY the property AS YOUR PRIMARY RESIDENCE for two of the last five years. The IRS may not consider the part that you rented out or deducted as a home office to be part of your primary residence.
Let's imagine that my father-in-law Ralph were 40 years younger, ran a construction business and used his unattached garage as a home office. The garage accounts for 10% of his property. Now the simple equation becomes more complicated.
In that case, 10% of the property is NOT eligible for the home sale exclusion. Instead, my in-laws would pay tax on 10% of the $400,000, an amount equal to an $40,000 capital gain. (For the typical Massachusetts resident, that would cost about $10,000 in taxes.)
Or, let's imagine that Martha and Ralph decided five years ago to spend most of their time in Florida, and rented out their home during their absence. Even though it was the family home for a very long time, they did not OCCUPY the property for at least two of the last five years.
That means they would not be eligible for the home sale exclusion at all. IRS rules say they would owe capital gains tax on the full $400,000, which for the typical MA resident would cost $100,000 in state and federal income taxes.
There are other complications related to depreciation, but that is a story for another day.
The bottom line is that every year we see clients get sideswiped by an unexpected capital gains tax that could have been avoided with some advance notice and planning. If you are even THINKING about selling your home in the next few years, it is worth a call to our office to see if there might be any pitfalls to be avoided along the way.
Goldberg & Vaccaro Tax Services LLC specializes in tax preparation and accounting services for individuals and small business owners. We recently moved our main office to Burlington MA.
Please give us a call if we can help you:
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