Tania Soussan / For the Journal | writes: Selling your home at a profit is one of the few times you can make money on an investment and not pay tax.
There are, of course, plenty of rules and some caveats.
If you sell your main residence at a gain, you can exclude up to $250,000 of the profit – or $500,000 for couples filing a joint tax return – from your income. You must have owned and used the property as your main home for at least two out of the five years before the date of sale, according to the Internal Revenue Service.
That’s enough to cover most homeowners in this market where real-estate prices have not gone through the roof.
“Most people, even if they do have a gain, don’t pay tax, particularly in Albuquerque,” said CPA Jim Hamill, a tax specialist at Reynolds Hix & Co.
If you can exclude all of the gain, you get another bonus – less paperwork. It’s not necessary to report the sale at all on your tax return. But if you can’t or don’t exclude all the profit, you’ll have to file Form 8949. You’ll also have to report the sale if you received a Form 1099-S, Proceeds From Real Estate Transactions, according to the IRS.
Things do get a bit prickly if you used your home as a rental property before living in it yourself.
And “if they ever used the property for business purposes … then they could still have problems,” Hamill said. “They might not be able to claim the full deduction.”
The rules for a rental property are a bit complicated. The profit from the sale of a rental home is taxable, and a 2009 change in tax law requires home sellers to prorate the amount of the exclusion they can claim.
Take the case of a house that was used as a rental for eight years and then lived in for two years before being sold. The home was a rental for 80 percent of the time and a main residence for 20 percent of the time. Therefore, the seller can exclude 20 percent of the profit on the sale of the house from his or her income but must pay tax on 80 percent of the gain, Hamill said. Any rental use that occurs before 2009 is exempted.
Property owners who’ve claimed a tax deduction for having a home office must report any depreciation they claimed after May 6, 1997, as a gain.
That shouldn’t scare people off from claiming depreciation, Hamill said, in part because the tax rate will be lower at the time the home is sold.
“As long as somebody qualifies, most tax advisers would say, ‘Go ahead and claim it,’” he said.
The new IRS rule that allows filers to claim $5 a square foot for a home office deduction instead of calculating actual expenses does not include depreciation, by the way.
Hamill stressed that these sorts of complicated scenarios are uncommon. In 1,000 tax returns, only about 100 will include home sales and only 10 or 20 of those will involve something quirky, he said.
A couple of things to remember: If you own more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the profit you make when selling any other home. And you can exclude a gain from the sale of only one home in a two-year period.
So, what’s your main home? That’s a good question and one people sometimes are tempted to fudge the answer to by calling their vacation home their principle residence, said Hamill, who also writes a tax column for the Journal .
“There’s no bright line test. It’s sort of a list of factors,” he said. “This is the only asset where you can completely exclude the gain. It creates an incentive for people to say, ‘This is my primary residence.’”
Basically, if you have two homes and live in both of them, your main home is usually the one you live in most of the time. But you can prove that the home where you spent less time is your main home if that’s where you are registered to vote, have a driver’s license and are involved in organizations, for example.
A few more things to keep in mind:
You cannot deduct a loss from the sale of your main home. And converting your house into a rental generally won’t help because any loss is calculated based on the fair market value at the time you turned the property into a rental.
You can deduct only the property taxes you actually pay. Property taxes here are paid retroactively so the seller generally is charged for those taxes as part of the closing of the real-estate sale. The seller should use that settlement form to show how much property tax they can deduct. The buyer, meanwhile, cannot deduct that amount, Hamill said.
When buying a first home late in the year, be aware that you might not have enough expenses to itemize deductions and therefore won’t be able to deduct mortgage interest until the next year, Hamill said.
Special rules may apply when you sell a home for which you received the first-time homebuyer credit within three years. See Publication 523 for details.
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