Tax Tips
Home Conversion Will Become More Taxing - April 2009
Richard Scrivanich - Partner
When you sell your home, you become eligible for one of the most generous breaks in the tax code. The new housing act, though, will limit this tax benefit in some situations.
Explaining the exclusion
To understand how the new law will work, you should understand the basic tax break offered to home seller since 1997. If you sell your home at a profit, you may be able to exclude from tax up to $250,000 worth of gains. Married couples filing joint returns may be able to exclude as much as $500,000 of home sales gains. In order to take these exclusions, you must have owned the home and used it as your principal residence for at least two of the five years preceding the sale date. Taxpayers can use these exclusions multiple times, but not more than every two years.
Moving violations
The tax law, as described above, provided opportunities for taxpayers owning two or more homes. A hypothetical Matt and Jennifer Jones, for example, might sell their appreciated principal residence and take a capital gain exclusion up to $500,000. Then Matt and Jennifer could move into their vacation home, wait two years, and take another $500,000 exclusion on a subsequent sale. They could employ similar tactics with homes used as investment property.
The new housing act will cut the tax benefits from such strategies. Essentially, if you move into a house that you have owned but not used as a principle residence, any gain on a subsequent sale will be partially taxed.
Example #1: Kenneth and Amy Brown buy a vacation home on February 1, 2009 for $200,000. On February 1, 2011 they move into that house, full time. On February 1, 2015 they sell the house for $320,000 after selling costs. At that point, the Browns have owned the house for six years but used it as a principal residence for only four years. For the other two years (one-third of their ownership) it has not been their principal residence. Thus, one-third of their $120,000 gain ($40,000) will not be eligible for the home sale exclusion. The Browns will owe tax on a $40,000 long-term capital gain.
The same results will apply if the Browns move into a home they had been renting to tenants. In that case, the Browns would have to pay tax on depreciation deductions they claimed while the house was investment property in addition to tax on the applicable long-term capital gain.
Employing the exceptions
Although the new law will reduce the $250,000 and $500,000 capital gains exclusions for home sales in some situations, as described above, it also includes some exceptions to the tougher new rules. For example, the new law does not consider how the house was used before January 2009.
Example #2: Say that Art and Janice Wilson bought a vacation home in January 1990 for $300,000. That house has appreciated tremendously and now would sell for $1 million. The couple could move into the house full time in November or December 2008. Two years after moving in, the Wilsons could sell the house. If they sell the house for $1 million, they'd have a $700,000 gain. They could use the entire $500,000 capital gain exclusion, with no reduction, and owe tax on only a $200,000 gain.
What if the Wilsons move into the house January 2010 and sell it in January 2012? Only one year (from January 2009 to January 2010) will be considered when computing the reduction in the home sale exclusion. That's the post-2008 period when the house was not their principal residence. The Wilsons will have owned the house for 22 years, so 1/22 of their gain will be ineligible for the home sale exclusion.
Suppose the Wilsons sell the house for $1.4 million, which gives them a $1.1 million net gain on the sale? Of that $1.1 million gain, 1/22 ($50,000) would be ineligible for the exclusion. The other $1.05 million would be eligible, so the Wilsons could take the full $500,000 exclusion and owe tax on a $600,000 long-term gain.
What's more, moving out of the house after you have used it as a principal residence won't reduce your exclusion as long as you meet the basic ownership and residence tests. Nevertheless, if you had been planning to move into a vacation home or rental property that you already own, doing so before year-end 2008 may be a significant tax saver.
If you have any questions regarding the above discussed topic, or any other tax matter, please feel free to give me a call at (562) 698-9891.
Return to Current Tax Tips
All rights reserved. For personal use only.
Do not duplicate or distribute without permission. All information in this
article is for informational purposes only.
Some of the articles included here were written in a prior
year or before a current tax law change. Therefore some of the information in
the older articles may not still be valid. Any dollar thresholds indicated
relate only to the year for which the article was written and could be different
for the current year. Please discuss with us your personal situation before
acting on any of the information provided. If you have any questions,
please give us a call at (562) 698-9891.
|
