I'll be out fulltiming later this year, I hope I hope. So, about selling my house.
I've talked with a real estate agent, but I'm still confused. I want to avoid capital gains tax but I have had a home office for many years. Does that complicate it? The money from the house sale will need to be earmarked for retirement income, so I gotta maximize it!
Any comments?
Vee
Howard said
05:22 PM Jun 13, 2007
Oh Boy. To answer your question, "Yes" the home office does complicate things.
But of course you know I'm going to elaborate. And it can be confusing, so read slowly and go over it a couple of times.
First of all, let's look at capital gains on the sale of a primary residence. You can exclude up to $500,000 capital gains (profit) from the sale of your home ($250,000 if single).
The exclusion applies if: 1) You owned the home during at least two years in the five-year period prior to the date of sale (ownership test) AND 2) You used the home as your principal residence for at least two years in the five-year period prior to the date of sale (use test) AND 3) You did not sell another home in the two years prior to the sale and exclude capital gains (the one shot per two years test).
NOTE: There are exceptions to these rules, but I won't go into them here.
Now the exclusion may be affected IF you used the home for business purposes or you rented the home out. In either case, you must reduce the "basis" in the home by the depreciation amount you COULD have taken - doesn't matter whether you actually took it at all or took less than the allowable amount. This won't affect most people because the depreciation you "could have taken" generally won't throw you into that "capital gains over $500,000" category.
Let's look at an example. Say you bought your home for $150,000 and then you added $20,000 in improvements. Your "basis" in the home is $170,000 - basically the cost of the home added to the cost of capital improvements. Unless the home sells for over $670,000, no capital gains for a married couple. If, however you COULD have taken depreciation for business use of the home that totaled $10,000 over the years, you would have to reduce your "basis" by $10,000 to $160,000. Again, no big deal for most of us, but it could throw some people into a capital gains situation.
However, the big question is whether you actually deducted depreciation for the business use of your home in prior years. IF NOT, your capital gains up to $500,000 is completely excluded.
IF YOU DID deduct depreciation then you WILL have to pay a "recapture tax". (I'm not talking about the expenses for the business use of your home you may have deducted, ONLY depreciation).
You cannot exclude from capital gains that portion of depreciation deductions you took on the home over the years. In fact, you have to report all that depreciation you took in prior years as a capital gain on Schedule D and that "recapture tax" might be at a higher rate than regular capital gains taxes.
So, if you meet the three criteria at the top AND you have less than $500,000 in capital gains ($250,000 single), you will not have any capital gains taxes. But if you deducted depreciation on your home in prior years, the IRS wants their money on that amount, and you have to report the total previously deducted depreciation as a capital gain and pay capital gains taxes on that portion whether or not you meet the $500,000 capital gains threshhold.
Believe it or not, I made it simple. But you can always go to IRS Publication 523 and get it in IRS-speak.
Hope that helps.
V4Vagabond said
05:40 PM Jun 13, 2007
Oh I'll take Howard-speak over IRS -speak anyday! Thank you Howard, this really is very helpful.
So in my situation, I HAVE deducted depreciation for the last, hmm, I think 12 years. So that means I will have to report the total of the depreciation I took on Schedule D and pay taxes on it, no matter what, right?
However, in 2 of the last 4 years I did not deduct depreciation (oversight on my tax preparer's part) -- so will those years simply not count or will I have to declare and to pay taxes on what I could have deducted those two years?
So will the amount of taxes I pay on that depreciation figure be based on my income -- and might it make a difference if I postpone selling my house until after the first of the year, since in 2008 I will be 'retired' more or less and making about half my former income?
I hope I'm not overdoing the amount of help I'm asking for, but I am really trying to get on the road this fall (thanks in part to the encouragement reading your site gives me!).
Vee
Howard said
09:18 PM Jun 13, 2007
Well, there is some good news.
You only have to report the depreciation you claimed on returns AFTER May 6, 1997.
But yes, you will have to report all the depreciation you actually took on your taxes after that time and pay taxes on that amount. You do not have to add in the amounts you could have taken for Schedule D tax purposes.
The amount that "you could have taken" or the ALLOWABLE DEPRECIATION" is only used to reduce the "basis" in your home (i.e. the lower your basis the more capital gain you will have). Again, I doubt the lowering of your basis will have any effect on your actual taxes, but I'll leave that up to you and your tax preparer.
I'm not a tax accountant or tax attorney, but I believe your income plays into the calculation of the tax. However, I have a hunch that the tax you will have to pay on the depreciation is minimal. Of course I can't know that for sure without all the numbers and you don't have enough money to pay me to figure it out.
I wouldn't hold up to sell until next year just because of this issue. I don't know if you have a mortgage, but I'd bet the extra mortgage payments would exceed the capital gains tax you will have to pay on the depreciation. Just another hunch.
Don't fret over this too much. It's complicated, but your tax preparer should be able to figure it out - sounds like they owe you a favor anyway.
V4Vagabond said
09:10 PM Jun 14, 2007
Thanks very much Howard, I do feel like I understand this as it applies to me now. Yes, there isn't anything to be gained by waiting to sell my house (except the possibility of a better market). And the loss is another year of not being where I'd really like to be which is out on the road somewhere!
And my tax preparer did offer to amend my return and refile it, but I wanted to wait to see if it made a difference in my selling decision.
I've talked with a real estate agent, but I'm still confused. I want to avoid capital gains tax but I have had a home office for many years. Does that complicate it? The money from the house sale will need to be earmarked for retirement income, so I gotta maximize it!
Any comments?
Vee
But of course you know I'm going to elaborate. And it can be confusing, so read slowly and go over it a couple of times.
First of all, let's look at capital gains on the sale of a primary residence. You can exclude up to $500,000 capital gains (profit) from the sale of your home ($250,000 if single).
The exclusion applies if:
1) You owned the home during at least two years in the five-year period prior to the date of sale (ownership test) AND
2) You used the home as your principal residence for at least two years in the five-year period prior to the date of sale (use test) AND
3) You did not sell another home in the two years prior to the sale and exclude capital gains (the one shot per two years test).
NOTE: There are exceptions to these rules, but I won't go into them here.
Now the exclusion may be affected IF you used the home for business purposes or you rented the home out. In either case, you must reduce the "basis" in the home by the depreciation amount you COULD have taken - doesn't matter whether you actually took it at all or took less than the allowable amount. This won't affect most people because the depreciation you "could have taken" generally won't throw you into that "capital gains over $500,000" category.
Let's look at an example. Say you bought your home for $150,000 and then you added $20,000 in improvements. Your "basis" in the home is $170,000 - basically the cost of the home added to the cost of capital improvements. Unless the home sells for over $670,000, no capital gains for a married couple. If, however you COULD have taken depreciation for business use of the home that totaled $10,000 over the years, you would have to reduce your "basis" by $10,000 to $160,000. Again, no big deal for most of us, but it could throw some people into a capital gains situation.
However, the big question is whether you actually deducted depreciation for the business use of your home in prior years. IF NOT, your capital gains up to $500,000 is completely excluded.
IF YOU DID deduct depreciation then you WILL have to pay a "recapture tax". (I'm not talking about the expenses for the business use of your home you may have deducted, ONLY depreciation).
You cannot exclude from capital gains that portion of depreciation deductions you took on the home over the years. In fact, you have to report all that depreciation you took in prior years as a capital gain on Schedule D and that "recapture tax" might be at a higher rate than regular capital gains taxes.
So, if you meet the three criteria at the top AND you have less than $500,000 in capital gains ($250,000 single), you will not have any capital gains taxes. But if you deducted depreciation on your home in prior years, the IRS wants their money on that amount, and you have to report the total previously deducted depreciation as a capital gain and pay capital gains taxes on that portion whether or not you meet the $500,000 capital gains threshhold.
Believe it or not, I made it simple. But you can always go to IRS Publication 523 and get it in IRS-speak.
Hope that helps.
You only have to report the depreciation you claimed on returns AFTER May 6, 1997.
But yes, you will have to report all the depreciation you actually took on your taxes after that time and pay taxes on that amount. You do not have to add in the amounts you could have taken for Schedule D tax purposes.
The amount that "you could have taken" or the ALLOWABLE DEPRECIATION" is only used to reduce the "basis" in your home (i.e. the lower your basis the more capital gain you will have). Again, I doubt the lowering of your basis will have any effect on your actual taxes, but I'll leave that up to you and your tax preparer.
I'm not a tax accountant or tax attorney, but I believe your income plays into the calculation of the tax. However, I have a hunch that the tax you will have to pay on the depreciation is minimal. Of course I can't know that for sure without all the numbers and you don't have enough money to pay me to figure it out.
I wouldn't hold up to sell until next year just because of this issue. I don't know if you have a mortgage, but I'd bet the extra mortgage payments would exceed the capital gains tax you will have to pay on the depreciation.
Don't fret over this too much. It's complicated, but your tax preparer should be able to figure it out - sounds like they owe you a favor anyway.
And my tax preparer did offer to amend my return and refile it, but I wanted to wait to see if it made a difference in my selling decision.
Vee