Tax Rates Vary for Gains on House
QUESTION: My husband and I are thinking of selling our home and buying a less expensive one this year. We would have a capital gain of about $200,000. We are not yet 55 years old, so we are not entitled to take advantage of the $125,000 tax exemption on capital gains for home sellers in this age bracket. Two different accountants have given us conflicting versions of what our capital gains tax liability would be in 1988. Would the $200,000 be taxed at a maximum of 28% regardless of regular income, or would it be taxed at the top rate of 33%?--J. R. D.
ANSWER: The answer is that some of it will be taxed at 15%, some will be taxed at 28% and a portion of what was taxed once at 28% will be subject to the 5% surtax on high-income taxpayers. Furthermore, you will lose a portion of your personal exemptions.
But first, we have to establish that the full $200,000 is taxable. Even if you realize profits of $200,000 from the sale of your house and do not buy a more expensive replacement residence, the full profit may not be subject to tax. For example, let’s say you sold a home for $350,000 on which you had a “tax basis” of $150,000--thereby generating a $200,000 profit. (The tax basis is essentially the cost of the house plus improvements.) Assuming your new home cost $300,000, you are liable for taxes on only the $50,000 difference between the sale price and the cost of the new home.
But, we’ll assume that your sale gives you a taxable profit of $200,000. And for the purposes of this discussion we’ll assume that the $200,000 is the full extent of your annual taxable income for 1988. (However, in all likelihood, your taxable income would be greater if you are employed or have other income.)
According to the Internal Revenue Service, your total tax liability on this $200,000 profit--assuming no other income or expenses--would be $57,092. Here’s how they arrived at that figure. The first $29,750 is subject to a 15% tax, or $4,462.50. The next $170,250 is subject to a 28% tax, or $47,670. The amount between $71,900 and $149,250, or $77,350, is subject to the 5% surtax, or $3,867.50. Finally, the loss of your personal exemption deductions is worth $1,092.
Waiting for more favorable tax timing won’t necessarily pay off, unless you’re nearing age 55. The IRS says tax rates in effect in 1988 aren’t likely to change. However, the income levels might be raised slightly as an inflation adjustment.
Q: I have a question regarding the $125,000, one-time exclusion for home sellers aged 55 or more. I read in a book that if you take the exemption and later wish you hadn’t, you can revoke your decision. I have never seen anything else about revocation in any other article on the exclusion. Is there really a revocation clause? --B. S.
A: Yes. According to the IRS, if you take the exclusion and want to change your mind later, you can retroactively revoke your use of this one-time tax exemption. However, you have only a few years in which to change your mind. You either must revoke your decision within three years of filing your return with the exclusion, or within two years of paying the taxes for the year that included the exclusion, whichever is later.
Say, for example, you sold your home in 1987 and filed your tax return with the exclusion in 1988. You would have until 1991 to revoke your use of the exclusion. However, if you sold your house in 1987 but didn’t pay taxes on your 1987 income until 1990, you could have until 1992 to make the revocation.
To take advantage of the exclusion, you must file a Form 2119, “Sale or Exchange of a Principal Residence,” with your income tax return. To revoke the exclusion, you--and your spouse, if you filed a joint tax return--must send a statement seeking the revocation to the closest IRS service center. You must sign the statement and include your Social Security number.
In the event your spouse dies before you file for the revocation, you should include the signature of the executor of the estate on the statement.
In addition, when you revoke your use of the exemption, you must refigure your taxes for the year in question and file an amended return if you owe additional taxes. Although the IRS will not levy a penalty on the amended return, you will be charged interest on the additional taxes owed.
Q: Can you please explain what a “subordinated debenture” is?--M. K. C.
A: Let’s start by defining a debenture. According to Barron’s Dictionary of Finance and Investment Terms, a debenture is a “general debt obligation” that is backed only by the integrity of the borrower. A bond that is unsecured--that is, not backed by a mortgage or lien on any specific assets--is a debenture. Corporations typically sell debentures, or debt issues, to raise money when selling stock is not practical or desirable.
A subordinated debenture is a bond of lower status among the ranking of a company’s debts. For example, if a company files for bankruptcy protection and its assets must be liquidated, a subordinated debenture would be repaid only after other debt issues with higher claims on the company’s assets were settled. Some subordinated debt may have lower-ranking claim on assets than other subordinated debt. Junior subordinated debentures rank below subordinated debentures.
Typically, the more junior a debenture is, the higher the interest rate it will pay, since the buyer is assuming a greater risk of not being repaid in full.
