Hang On to Some of Those Documents
If you’ve just finished paying to put a new roof on your home, like I just did, your first instinct is probably to shove the expensive invoice far away in a drawer somewhere, never to be seen again.
But before you do that, or worse yet, throw away the bill, you should remember that financial, legal and personal documents are important. They should be saved and readily available, at least for several years, and often for longer. They can be very helpful later when it is time to do your taxes, plan your estate, or even if your marriage falls apart.
Especially important are real estate documents, such as the bill for a new roof, remodeling the kitchen or adding a bedroom. That’s because of the way you will be taxed when you sell your property.
Under federal tax law, you pay tax on the profit you make when you sell your property. The profit is determined by subtracting what you paid for the property and the cost of any capital improvements from the selling price (minus costs of sale). In other words, your profit is what you have left after deducting what you put into the house, not counting normal maintenance.
Normally, you must pay federal tax on that profit. But that’s not what happens to most people who sell their house, because they take advantage of a “roll over” exception in the federal law.
If you sell your personal residence and buy another one of greater value within 24 months, you won’t have to pay any tax on the profit. For now. The profit is “rolled over” into the next house, but you will have to pay tax on it, when you sell the second house. Unless, of course, you buy another, more-expensive house again. You can keep rolling the profits into your next home, as long as each new house is more expensive than the last. When you buy a cheaper house, that’s when you’ll pay taxes. Let’s take an example. You buy a house for $100,000, and add $25,000 worth of capital improvements. You sell for $200,000. You’ve made $75,000 on the sale, but don’t have to pay any tax because you bought another home for $250,000. If you sell the second home for $350,000, and then move into an apartment for several years, you’ll have to then pay tax on the $100,000 you made in the second house, and the $75,000 you made from the first one.
But, remember, the Internal Revenue Service is not going to take very kindly to your contention that you invested $25,000 in capital improvements if you don’t have the documentation to prove it. No matter how long ago it was.
There is another exception you can use to avoid some taxation. You are allowed to exclude $125,000 of your gain, if you have lived in your house as your principal residence for three of the last five years, and you or your spouse is 55 years or older. This is a once-in-a-lifetime exception. Neither you nor your spouse can use it again. And it is not automatic; it must be specifically elected by the taxpayer.
In any event, it’s extremely important that you save records in a safe, accessible place. There are several books on the market with forms to chronicle expenses and with information on storing important documents. Also, there is a computer program and book package that will help you keep track of your legal, financial and personal records. (“For the Record,” by Carol Pladsen and Ralph Warner, Nolo Press, 950 Parker St., Berkeley, Calif. 94710. The book is $49.95.)
Klein, The Times’ senior staff counsel, cannot answer mail personally but will respond in this column to questions of general interest about the law. Do not telephone. Write to Jeffrey S. Klein, Legal VIEW, The Times, Times Mirror Square, Los Angeles 90053.
