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 For you convenience, we have developed an industry specific worksheet for you to capture your allowable deductions.
If you are planning on selling property, you need to be aware of changes that can affect your tax liability. Below are guidelines for the Sale of Your Principle Residence and how a Tax Deferred Exchange might be an option for the sale of other property. Sale of Principal Residence Most homeowners will benefit from the complete overhaul in rules governing the sale of their principal residence (Code Sec. 121, as amended by the Taxpayer Relief Act of 1997). Joint taxpayers can exclude up to $500,000 of gain, while single taxpayers can exclude up to $250,000. Under the old rules, a seller had to purchase continually more expensive homes to take advantage of the rollover provision, Thus, when the objective was to downsize or rent, the rollover provision was not available, and the one time $125,000 exclusion for taxpayers 55 or over provided only limited relief with many traps for the unwary. In contrast, the new law provides an exclusion rather than a deferral. Thus, homeowners have greater flexibility and are not forced to make home buying decisions based primarily on tax considerations. The old rules have been replaced, effective for sales of a principal residence occurring after May 6, 1997. A taxpayer can elect to use prior law for sales made: (1) before August 5, 1997, or (2) after August 5, 1997, under a binding contract in effect on that date. A home seller with gains in excess of the exclusion may prefer to use the old law to roll the gain over into a new house. Ownership and Occupancy Requirements A seller must have owned and occupied the residence as a principal residence for a least two of the five years prior to the sale or exchange. The law does not require that the home sold have been the principal residence at the time of purchase or sale. A married couple must meet the following requirements to obtain a $500,000 exclusion: (1) the couple must file a joint return; (2) either spouse must have owned the residence for at least two of the five years before the sale; (3) both spouses must have used the residence as their principal residence for at least two of the five years before the sale; and (4) neither spouse can be ineligible for the exclusion as a result of the once-every-two" years limit. If one spouse is ineligible, the other spouse is limited to a $250,000 exclusion.
Hardship Relief A taxpayer who fails to meet these requirements due to a change in their place of employment, health, or unforeseen circumstances (which will be described in future regulations) can still exclude some or all of the gain. The $500,000 or $250,000 maximum exclusion is pro-rated based on the fraction of the two year period for which these requirements are met. For example, a single taxpayer selling a residence after only six months to accept a job in another city is entitled to a maximum exclusion of $62,500 (1/4 of $250,000). The two year requirement is also relaxed for individuals forced to move to a nursing home or other licensed care facility. Divorce or Separation In a divorce or separation, the former spouse not granted use of the property will be treated as using the property as a principal residence during the time the resident spouse is granted use of the property under a divorce or separation instrument. This provision corrects an inequity under prior law, under which the spouse not granted use of the property lost the prior law tax breaks since the house was no longer a principal residence. Once Every Two Years Limit The exclusion can by used on a continuing basis but not more frequently than once every two years. For purposes of this rule, however, pre-May 7, 1997 sales are not taken into account. If a single taxpayer who is otherwise eligible for an exclusion marries someone who has used the exclusion within the two years prior to the marriage, the newly married taxpayer is entitled to a maximum exclusion of $250,000. Once both spouses satisfy the eligibility rules and two years have passed since the exclusion was allowed to either of them, they may exclude up to $500,000 or gain on their joint return. This is in contrast to the "tainted spouse" problem that, under prior law, prevented a taxpayer, typically in a second marriage, from making use of any portion of the old $125,000 exclusion if the other spouse had made prior use of the exclusion. Who Loses Two types of sellers are likely to wind up losers: (1) wealthy taxpayers in high priced areas with gains in excess of $500,000, (2) those who purchased a home in an area that has experience tremendous price appreciation, and (3) those who have traded up over decades of home buying and now find themselves sitting on huge deferred gains in excess $500,000. The Taxpayer Relief Act of 1997 does not wipe the slate clean of accumulated deferred rollover gains. Therefore, taxpayers may face an unexpected capital gains tax on the sale of their next principal residence with a tax they would not likely have faced under the old rules. Record Retention The new law does not per se exempt taxpayers from keeping records. In reality, however, most taxpayers will not exceed the $250,000/$500,000 exceptions. The safest course of action would be to maintain records for home improvements that increase the basis for a house, regardless of one's profit expectations. Tax payers should hold on to records relating to the old rollover provisions as long as they are subject to these rules, (i.e., until after a sale triggering the recognition of deferred rollover gains), plus an additional four years for the statute of limitations. Tax Deferred Exchanges Anyone who is selling real property (other than their personal residence) and plans to purchase other real property should consider a tax deferred exchange. While it is not appropriate in all circumstances, in most cases it can be the most profitable decision you will ever make! What is a Tax Deferred Exchange? A tax deferred exchange is no longer a complicated tax maneuver reserved for the wealthy. Congress recently simplified the procedures and made it a viable option for all taxpayers. A tax deferred exchange is very similar to simply selling your property and then buying replacement property, except you don't pay any taxes. Through the use of a qualified intermediary, you dispose of your existing property and the qualified intermediary hold the proceeds of the sale. When you select replacement property, the qualified intermediary purchases it for you. It is a simple and effective tax planning tool. 1031 DEFERRED EXCHANGES: GOOD NEWS FROM THE IRS In recent years, property owners have turned increasingly to exchanges of real property (IRC Code 1031 Exchanges also known as, a Starker Sale) to avoid paying income tax on real estate which they are selling. Tax deferred exchanges are sometimes mistakenly referred as "tax free" exchanges. In fact, the exchange only postpones the payment of taxes to sometime in the future. Often, the 1031 exchange involves three parties: the seller, the buyer (for cash), and a third party who owns property (which the seller wants to acquire in exchange for his property), but who is otherwise not interested in the exchange or trade. This technique has been popular for a number of years, and as it has grown in popularity, so has the demand for greater tax flexibility in structuring the transaction. Often, it is difficult to identify the "third party" at the time the buyer and seller make their deal. Over the years, the IRS has permitted "deferred exchanges" which are nothing more than arrangements which allow the seller to "find" the third party some time after the first transaction closes. 1. DEFINITIONS While the IRS does not break any new ground in its definitions, it does label aspects of the transaction with names which no doubt will become part of the lingo of the trade. For example, delayed exchanges will be known as "deferred exchanges". The seller's property which he is transferring is known as "relinquished property" and the property which he ultimately receives is "replacement property". 2. IDENTIFYING THE REPLACEMENT PROPERTY The regulations require the seller to identify the replacement property within the 45 day identification period. Briefly, the seller must submit to a third party (an escrow company, for example) a written document before the end of the 45 day period specifically identifying the property. The IRS also permits the seller to identify several replacement properties within specific limits. Basically, the seller can identify up to three replacement properties so long as the total value of these properties does not exceed 200% of the fair market value of the property being sold. Also, the seller can revoke a previous identification before the end of the 45 day period. When the seller identifies property under construction as replacement property, the fair market value test is met by using the estimated value at the time he takes delivery. 3. CONSTRUCTIVE RECEIPT One of the great fears in a 1031 exchange is that the seller inadvertently receives taxable proceeds. Fortunately, the regulations take a fairly common sense approach by identifying a number of arrangements under which deferred exchanges can be structured. The seller is permitted to use virtually any intermediary other than a related party (a relative or entity in which the seller has an interest). However, the regulations do not change the long standing rule regarding constructive receipt; the seller cannot have the right to receive or in any other way obtain the benefits of the cash held for his benefit. 4. OTHER MATTERS The IRS will permit the seller to receive the interest accrued while the funds are held in escrow during the deferred period. What Are The Mechanics of an Exchange? While there are many variations to how exchanges are handled, a typical exchange would proceed as follows: 1. The Taxpayer lists his or her property for sale. 2. The Taxpayer enters into an exchange agreement with an escrow or exchange company. 3. The escrow company completes the sale and transfers the proceeds to an insured bank or brokerage account which accrues interest for the benefit of the Taxpayer. 4. The Taxpayer locates one or more replacement properties and enters into a purchase and sale agreement to acquire them. 5. The escrow company arranges for the transfer of the proceeds from the secure account to the new escrow and completes the purchase of the replacement property.
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