The largest business transaction incurred by most taxpayers is the sale of their personal residence.
In January after the sale of your home you will most likely receive a form 1099-S, the form on which the sale of real property is reported. If the gain from the sale of your residence is completely excluded or the sale results in a loss, the sale does not need to be reported on your tax return.
Current tax law, which went into effect May 6, 1997, excludes up to $250,000 ($500,000 if married filing jointly) of gain realized on the sale or exchange of a personal residence. There are three tests for the full exclusion rules to apply:
• Ownership. The taxpayer must have owned the home for at least two of the five years before the sale.
• Use. The taxpayer must have occupied the residence as a principal residence for periods equaling at least two years within the five-year period ending on the date of the sale. This requirement is satisfied even when the two years are not concurrent.
• Once in two years. The taxpayer cannot use the exclusion for any other residence sold during the two-year period ending on the date of the sale.
There are certain situations that may prevent a homeowner from occupying and owning a home for two years. Exceptions to the rules are a change of employment, health, or unforeseen circumstances. A partial exclusion is available and is based on a fraction of the allowable exclusion.
Computing the gain on the sale of a residence will require reviewing two closing documents- the original purchase of the home and the sale of the home. The original closing document establishes the purchase price plus some closing fees that are added to the basis of the home. The original closing document also indicates the date ownership was taken for the purposes of computing the two-year test. The buyer should have kept track of the expenses that can be added to the home’s basis such as improvements, additions, landscaping and etc. The selling price, taken from the sales closing document, less any selling expenses such as the broker’s fees and other closing costs is the adjusted selling price. The adjusted selling price less the adjusted basis is the capital gain for tax purposes. If the gain is less than the $250,000 ($500,000 if married filing jointly) then no gain is reported for tax purposes.
Points are not usually part of the profit calculation since they are generally deducted directly in the year the home was purchased. If the home has been refinanced, the points paid to refinance a home mortgage are not deductible in full in the year paid, but usually are deductible over the life of the loan. However, if you are financing a mortgage for a second time, the balance of points paid for the first refinanced mortgage may be fully deductible at payoff. If some non-amortized points still exist upon sale of the home those points are fully deductible in the year of the sale.
Although the $250,000 and $500,000 thresholds for gain are substantially high, it is recommended that homeowners maintain good and complete records of any improvements. Future intent on the property is not always clear today. A conversion to a rental property is not uncommon. Also, rules relating to marriage, remarriage and divorce get complicated. Each case should be looked at individually. In all instances, it is wise to have kept all the records and seek out the assistance of a tax preparer to assist you in benefiting from the transactions.
Julie M. Sturgeon is a Certified Public Accountant in Valencia, specializing in individual and business tax issues. She can be reached at 251-6031 or Julie@cpasturgeon.com . “Its Your Money” appears Sunday and rotates among SCV financial professionals.