Federal tax changes affect gain on sale of second homes
Posted Oct 30, 2008 @ 2:26 pm, Viewed by 1964 Visitors, Read 2195 Times.The U.S. Government did a great thing for homeowners back in 1997. The Taxpayer Relief Act allowed a homeowner to exclude up to $250,000 of gain on a residential sale. Married homeowners filing jointly could exclude up to $500,000 of gain.
Tax-free profit - that's hard to beat. Many of us were able to use the exclusion and sell a property, then upgrade to a better home. With our economy going the way it is (not so good), Congress is making some changes that will affect the home sale exclusion.
As the law is currently written, a homeowner must reside in the residence for two out of the last five years. Meeting this test allows the homeowner to take the full exclusion. The gain exclusion can be used once every two years.This means a homeowner could theoretically own two houses, living in a residence for two years then moving to the next one and selling the first for a tax-free gain. With the proceeds from the first home sale, he could buy another house, etc.
Beginning January 1, 2009 the rules will change. From that day forward, the exclusion will be limited to "Qualified Use" - that is, the time the owner resided in the home. When a home is used as a rental or vacation home, that period will be considered "Non Qualified Use" and subject to taxable gain.
Here's an example: A couple buys a home on January 1, 2009 for $500,000. They live in the home two years and rent it out for one year. The house is sold on January 1, 2012 for $1,000,000.
- Under the old law, the couple met the two out of five year requirement and their gain would be excluded from capital gains taxes.
- Under the new law, the couple would have 1/3 (one out of three years owned) of the gain taxed at capital gains tax rates. Two thirds of the gain would remain tax free.
The new law is still good for homeowners, just not as good as it used to be!
Properties purchased prior to 2009 then sold 2009 or later
The period a property was owned prior to January 1, 2009 is not subject to the allocation. In other words, it's not taxable for capital gains if the owner met the "two out of five" criteria.
Example: A couple bought a home on January 1, 2005 for $300,000. They use it as a second home and make it their primary residence on January 1, 2010. Two years later, they sell the home for $1,000,000.
The couple has met the "two out of five" criteria for gain exclusion. But for the year 2009 the house was their second (not primary) home. That one year out of eight that the couple owned the home makes the fraction for calculating their taxable gain 1/8 X $500,000 gain = $62,500 to be taxed at capital gains rates.
Summary of the tax law relating to sales of residential properties
This is a complicated issue - let's start from the beginning.
- If a single person lives in a home for two out of the last five years and owns it for at least two years, he can exclude up to $250,000 in gain on the sale of that residence.
- If a married couple filing a joint return meets the same criteria (both must have lived in the home two out of the last five years) they can exclude up to $500,000.
- If the owners live in the home (for two out of the last five years) and then rent it out or use it as a vacation home and sell the property by December 31, 2008, they still get the full gain exclusion.
- If the owners live in the home (for two years out of the last five) and then rent it out or use it as a vacation home and sell the property AFTER December 31, 2008, the period after 12/31/08 (when the property is a rental or second home) until the time the property is sold is considered "Non Qualified" use and the property becomes subject to the allocation.
- The period that a property is used as a vacation home or rental up to 12/31/08 does not become a problem (does not create a taxable gain) as long as the couple has lived in the home for at least two out of the last five years.
- For those of us who own just one real estate property and use it as a principal residence, after you've owned and lived in the home for two years you can exclude your capital gain the same way as before! It only gets difficult when owners move out of their home and sell it later at a gain.
Realtors: If your seller is looking at offers and contemplating, it is important for them to know this tax law if it affects them! Understanding the rules might help us get a few more sales by the end of 2008.
Prospective sellers: Check with your tax attorney or CPA. Other factors not discussed in this article may affect your decision and the amount of taxable gain on your transaction.
Aloha, Mike
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Hi Mary,
In your case, the "non-qualified use" clock started ticking on January 1st. If you move to Maui and start living in the condo in the next couple of months, wait two years and you should have most of your $250,000 exclusion intact. The longer you put off moving in (after January 1, 2009) the longer you will have to stay in the condo to recoup the gain exclusion.
There are other factors involved. For example, when you're ready to sell, where will the market be? Right now the market is soft, although I imagine your condo's value is still above what you paid for it. Two or three years from now, hopefully the real estate market will be back to steady growth and you'll have lots of equity to cash out on and use for the assisted living facility.
If your anticipated gain when you sell is substantiall less than $250,000, the allocation of gain might not even be a factor.
Check with your personal tax advisor before making a decision as individuals have their own unique tax situations.
Aloha, Mike
bryan
We purchased a home #2 in the spring of 2007 that needed remodeling. Finally completed the remodel in the fall of 2008. In the meantime we were attempting to sell home #1 without success during the downfall in the real estate market. We moved into house #2 in nov. 2008 and rented out house #1 in March 2009.
House #1 was purchased in 1996 for $250,000. It has appreciated to approximately $500,000 today.
How long do we have to sell house #1 until we lose the tax exclusion?
If i'm understanding this right, will i have to pay capital gains tax on house #1 during the period of time between jan. 1, 2009 and the time the house #1 sells?
if I do not live in house #1 for the last 2 out of 5 years do i loose all tax exclusion or just a part of it?
Thanks, Bryan
Hi Bryan,
Have you lived in house #1 for two out of the last five years? If the answer is yes, then you and your wife ("we" sounds like you're married) have a $500,000 gain exclusion.
Starting on January 1, 2009, that exclusion slowly erodes for the time it's used as a rental property. Since you have about a $250,000 gain if you sell it today, it sounds like there will not be a large capital gains tax to pay.
For example, If you rent house #1 out for all of 2009 and you lived in it from 1/1/96 to 11/30/2008, the fraction of gain that's taxable would be about 1/14th. Math: $250,000 x 1/14 = $17,857 times your capital gains tax rate.
If you don't live in house #1 for at least two out of the last five years, you lose all of the gain exclusion.
Check with your CPA to verify, there may be other factors that could come into play.
Aloha, Mike
Bill
I bought my house # 1 in June/1996. I moved out into house #2 in April of 2005. I am trying to sell house # 1 in 2009. Last april was 3 years since I moved out of house #1. The capital gain is approx. 300K. What is the gain exclusion??
Thanks
Bill
Hi Bill,
If you April 2008 marked 3 years since you moved out of the house, then you no longer meet the "two out of the last five years" criteria and generally there is no gain exclusions.
There are some exceptions for hardships, such as loss of job. Don't push it though, if you didn't really have a hardship I would not try and use that reasoning for an exclusion. Instead, if feasible you might want to move back into the house for a time until you've reached 2 out of the last 5 years again and then the exclusion should be in place.
Aloha, Mike
Pete
I bought house number 2 as an investment in 2005 for 60k, took out a second mortgage for 75k to fix it up. Sold it in 2009 for 135K. do I have capital gains on this house?
Hi Pete,
House 2 - $60k + 75k = $135k appears to be your basis. If you took no depreciation, then your basis equals your selling cost and there's no capital gain. On top of that, you probably had selling expenses (commissions, escrow fees etc.) to deduct and then you might have a tax deductible loss.
Please consult with a tax professional as each person's tax situation can be different. State taxes vary as well.
Aloha, Mike
Ron, NY
I have a second home bought for 120k in 1984 and put about 50k in over the last several years. It's current estimated value is $500,000. How much capital gains would I pay on the 330,000 in profit? I live in New York City
.
Hi Ron,
Maximum capital gains rates are currently 15%. You may have $49,500 in Federal tax due upon the sale.
Other factors: 1) Have you depreciated the home in the past 25 years? If so, your basis will be reduced by the prior years' depreciation expense which will increase your gain. 2) Selling a home usually generates selling expenses such as commissions, advertising, termite inspections, etc. These can reduce your taxable gain.
Please consult with your CPA or Tax Attorney regarding New York City / New York State taxes.
Taxes are a consideration when selling a home. More importantly, you are able to sell for a profit. A lot of other people are unable to do that at this time.
Aloha, Mike
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Mike Bates is a realtor associate on the island of Oahu. He's lived on Oahu, Maui, Molokai and the Big Island for 28 years and is here to share his knowledge of the Hawaiian Islands with you. Read More
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I purchased a condo in Maui in June 2004 with the intent that it would become my retirement home. I rented it out without ever living in it as I was still living and working in California. I did not own a residential property in California and now that I am retired I had intended to move to Maui and live in the condo, and eventually sell it to pay for an assisted living facility when I reach that stage of life. If I live in the condo equal to or longer than the time it was a rental, would I still lose my $250,000 exemption? Anyone have an opinion?