Homeowners Over 55 : Plan Needed to Gain Most From Tax Break
Just about every homeowner has heard of the one-time tax exclusion that allows sellers who are 55 or older to keep up to $125,000 in their resale profits tax free.
But this important provision in the nation’s tax codes isn’t nearly as simple as it sounds, tax experts say. Older people who sell their home and then try to sort out the details later run the risk of losing thousands of dollars in tax deductions and also miss a golden opportunity to do some important financial planning.
“You’ve got to look before you leap if you want to make the most of this exclusion,” said Michael Fredlender, a tax manager with the Los Angeles office of consultants and accountants Kenneth Leventhal & Co.”If you don’t do some planning, you could lose out on thousands of dollars in tax savings.”
Those tax savings can be even greater if they’re combined with the benefits of Proposition 90, which was approved by voters last Tuesday. The measure allows people over 55 to move to another county and retain their current property-tax rate, as long as the new county approves it.
To be eligible for the exclusion, a homeowner must be at least 55 years old and have used the property as his primary residence for three of the last five years. Legislation that President Reagan is expected to sign into law this week would loosen the residency requirements for some older homeowners who have been hospitalized, institutionalized or placed in a convalescent home.
If a homeowner is within a few years of turning 55 or doesn’t yet meet the residency rule, it may make sense to delay moving until both requirements are met.
“You can’t let taxes guide your every move, but if you don’t have to sell your home right now, the big savings you can get by qualifying for the exclusion can be worth waiting for,” said Karen Block, a partner in the Encino-based accounting firm of Block, Klein, Levin & Co.
Still, meeting the age and residency requirements doesn’t automatically entitle a homeowner to take the exclusion; it merely makes him eligible for it.
Maximizing Tax Savings
Following are some frequently asked questions about the one-time tax exclusion, with answers and pointers that can help homeowners maximize their tax savings. The responses reflect information gathered from accountants Fredlender and Block, as well as from other sources.
What if I exercise the exclusion, but my resale profit is more than $125,000?
Any profit over $125,000 will be subject to taxation. However, you can defer paying taxes on that excess profit by buying a home within two years at a cost that is equal or greater than the adjusted sales price of your current home, less the $125,000 exclusion.
For example, let’s say you sell your home for $245,000 and pay $15,000 in commissions and other eligible expenses. Your adjusted sales price is $230,000. You have a profit of $150,000, so utilize the $125,000 exclusion.
You can defer paying taxes on the remaining $25,000 in profit if you purchase another home for at least $115,000--the difference between the $230,000 adjusted sales price of your current home and the $125,000 exclusion.
My spouse and I are selling our house. I’ve never used the exclusion, but she and her previous husband took it before he died. Are we eligible to use it again?
No. It’s what some tax experts call the “tainted spouse” rule: If one spouse has previously used the exclusion prior to the marriage, neither the husband nor the wife can use it again.
Still, certain people can avoid this potential hazard with a little tax planning. Say a 70-year-old widower who hasn’t used the exclusion is going to marry a 65-year-old widow who used it in her previous marriage. If the widower plans on selling his current house, he should sell it before the wedding so he can take the exclusion.
If he sells his home after the wedding, the “tainted spouse” rule will prohibit him from using the exemption.
If my spouse and I die before either of us use the exclusion, can it be passed on to our heirs?
No. However, the value of the home on the date of the last spouse’s death is the value the heirs can use for tax purposes. So, if you bought a house for $50,000 and it was worth $200,000 when you died, its value to your children would be $200,000. If they later sold the home for $250,000, they would pay taxes on just $50,000 of the gain.
I’m selling my home for an $85,000-profit now. Since the limit is $125,000, can I keep the $85,000 profit from my current sale tax-free and also keep $40,000 in profits from the sale of my next home?
No. The exclusion is a one-shot deal. You can’t use a portion of the exemption today and use the remainder for a later sale.
Should I automatically take the exclusion if I’m 55 or older and sell my home for a profit?
Nothing in the tax world is “automatic.” If you’re planning on buying another home, it may make sense to pay taxes on your profits from the current sale, and use the one-time exclusion when you sell your next home. The idea is that you’ll be able to sell your next home for a bigger profit than you’d realized from the sale of your current house, and thus maximize your tax-free profits.
Say you’ll net $60,000 from the sale of your current home. If you exercise the one-time exclusion now, you’ll only get to pocket $60,000 tax free.
On the other hand, if you don’t exercise the exclusion today and eventually sell your next home for a $125,000 profit, you’ll get to keep $125,000 tax free instead of just $60,000. You may also be able to defer taxes on the sale of your current home.
Perhaps the only time you should “automatically” take the exemption is if you’re selling your home and plan on renting for the rest of your life, or if the next home you buy will cost less than the one you’re selling now.
My spouse and I are getting a divorce, and neither of us has ever used the exclusion before. Should we sell the property before the divorce is finalized, or afterward?
If you sell the property before the divorce is finalized and take the one-time exclusion, neither party will ever be eligible for the exclusion again. So, it’s probably best to sell the property after the divorce because each spouse will retain the right to use the one-time exclusion in the future.
An even better alternative may be to award title to the property to one spouse, and give the other spouse community assets of comparable value. Both parties would still come out about even and each would still be eligible to take the exclusion at a later date. However, the spouse who gets the home will be able to sell when he or she is ready, rather than selling as part of a court-approved settlement.
If I take the exclusion on this year’s tax return but later decide that I want to revoke it, can I?
Yes, but only during a certain time span. Depending on when you took the exclusion and filed the return, you may have as many as three years to change your mind. An amended return will have to be filed for the year the exclusion was taken.
There are really only two reasons why you might want to revoke the exemption. The first might be because you originally took the exclusion thinking that you wouldn’t buy another home, but have since changed your mind. The second is that you have since remarried and now want to avoid the “tainted spouse” rule.
Since the one-time exclusion is the most lucrative tax break many homeowners can ever get, it often pays to consult a tax planner. If nothing else, contact the Internal Revenue Service and request Publication 523, “Tax Information on Selling Your Current Home,” to get more details.
