Home-Profit Exclusion 1-Shot Deal
QUESTION: I am in my mid-50s and am in the process of selling a home for the first time. I have not decided yet whether to buy something smaller or rent. My decision will depend in large part on my tax situation. What happens if I use the home-profit exclusion now, and then decide later that I want to buy another house? When I go to sell the second house, can I use the rest of the $125,000-gain exclusion I don’t use the first time?--R. B.
ANSWER: Taxpayers get only one shot at this popular tax break--even if they don’t use the full $125,000 profit exclusion allowed.
So no, your plan won’t work.
Because this is a once-in-a-lifetime break, you should consider carefully. You don’t want to opt for the exclusion now, only to discover later that your haste cost you thousands of dollars in taxes.
Keep in mind that you don’t qualify for the exclusion unless you are at least 55 years old and have used this house as your principal residence for at least three of the past five years.
If you meet those tests, you can opt for the exclusion--that is, the right to exclude from your taxable income the profit from the sale of your house. Up to $125,000 may be excluded.
Say you sell your house for $50,000 profit and decide to take the one-time exclusion. Under the IRS rules, you don’t have to pay taxes on that usually taxable profit. But if you buy another house a few years from now and later sell it for a $70,000 gain, you will be taxed on the full profit--even though your two profits combined are still less than the $125,000 maximum exclusion.
If you are wavering on whether to buy again, you are probably better off to delay using the tax break. You have three years to make up your mind. That is, you have three years after the tax return is due for the year of the sale.
So, if you sell in June of this year and your return is due on April 15 every year, you have until April 15, 1990, to make a choice. By then you will know whether you must pay taxes on the gain or elect to take the exclusion. Why? Because you must acquire a new home within two years of selling your current home in order to defer the payment of taxes. The government requires taxpayers to defer the tax on the gain from the sale of a home until they elect to take the one-time exclusion. However, if they fail to invest the profit from the sale of a home within two years and they are under 55 years of age, they must pay the tax.
If a taxpayer buys a cheaper house than the one that was sold, the gain on the sale will be taxed unless the one-time exclusion is used.
Q: While reading the newspaper stories about the tax reform proposals, I saw several references to something called an alternative minimum tax. The stories said some people will lose some of the intended benefits of tax reform because of this tax. What is it?--A. K.
A: It is a way for the government to prevent big investors and other taxpayers with enormous deductions from entirely avoiding income tax. Just as the name suggests, it is an alternative way of figuring a taxpayer’s income tax bill and guarantees that everyone pays at least a bare minimum amount of taxes.
Taxpayers who are required to use this tax computation method must add certain amounts back into their adjusted gross income before figuring their tax, which is figured at a flat 20%.
An investor who plays the stock market and wins big is a good candidate for paying alternative minimum taxes.
To encourage investment in the stock market, the government gives such investors a tax break when they sell their stocks and make a profit. But if such profits account for too much of the taxpayer’s income in the government’s eyes, the alternative minimum tax is triggered. (For specifics, consult pertinent IRS publications or your accountant or tax preparer.)
In that event, here’s what happens. You must add those amounts that accountants call tax-preference items (such as capital-gains deduction, accelerated depreciation on real estate and incentive stock options) to your adjusted gross income. From that amount you are entitled to deduct most itemized deductions (such as mortgage interest on your principal residence and medical expenses) but not state and local taxes.
The result is your alternative minimum taxable income. Depending on whether you are filing a joint or single return or filing as a head of household, that sum is further reduced--by $40,000, $30,000 or $20,000, respectively. The balance is taxed at a flat 20%.
Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.
