Juggling Houses Won’t Erase Tax Woes
QUESTION: I read with interest and some remorse your recent column on buying a new home for less than you sold your original house. I was certainly unaware of the potential tax consequences of doing this. But I got to wondering if there was a possible way out of the problem, since I now face a huge tax bill. Suppose I sell my less-expensive second house within the two years I am allowed to find a replacement house of equal or greater value than the first and then buy a third house that is more expensive than what I sold the first one for? Will this nullify my tax problem?--L. G.
ANSWER: Not entirely, but your tax problem could be eased.
Here’s the situation. The Internal Revenue Service says you are liable for taxes on any profit that you realize from the sale of your principal residence that you do not invest in a new home. (Homeowners over age 55 are allowed to shelter $125,000, but that’s the only exception to the law.) The IRS gives you 24 months in which to buy a replacement house. According to our experts, the government allows you to designate the house to be considered this replacement residence.
Here’s how the plan you have suggested could work. Let’s say you sold your original house for $500,000 and bought a replacement for $350,000. You would potentially face paying taxes on $150,000 worth of gain that was not reinvested. But if within that 24-month period, you sold this second residence and bought a third for $600,000 and designated that house as your replacement one, the original tax bill would be erased.
However, you would face taxes on any gain you realized from the sale of the second residence. So, if that second house sold for $380,000, you would be taxed on a $30,000 gain that was not reinvested because you are not allowed to reinvest gains from two houses into a third.
Also, be prepared to file an amended tax return for the year of the first sale.
Choosing Between Ex-Husbands’ Benefits
Q: I was married for the first time for 21 years. My second marriage lasted 10 years. Which ex-husband’s Social Security benefits may I apply for? I understand that I am technically eligible to apply for either one’s benefits since both marriages lasted at least 10 years before the divorce. But I know that my first ex-husband’s Social Security account is larger. How do I find out how much money I would be entitled to draw under his account when I reach retirement age, and how do I get his Social Security number?--S. B.
A: You are allowed to draw Social Security benefits under the accounts of whichever ex-spouse you wish. No doubt you will choose the account of the “ex” whose earnings were higher and who is entitled to the higher benefits. However, if you were still married to husband No. 2, you would not be able to claim the benefits of husband No. 1, even if his account were more attractive. (There is one exception: If you remarried after age 60 and your former spouse has died, you are entitled to claim benefits on your deceased spouse even if you are currently married.)
You can obtain the Social Security number of your ex-spouse by contacting your local Social Security office and giving them all the identifying information you have. Your ex-husband’s birth date, last known address, employers, mother’s maiden name and birthplace are some of the important facts you should collect. Also be prepared to prove that you are an ex-spouse who is entitled to draw benefits. At the very least, you will need to produce a marriage and divorce certificate.
A Social Security worker will open a file for you and help you get the information and benefits to which you are entitled. By the way, the payment rate for ex-spouses is 50% of the primary wage earner’s benefits, minus a certain percentage if you elect to draw Social Security benefits before turning age 65.
How to Give Away Money Tax-Free
Q: I know that an individual may give up to $10,000 tax-free to another individual each year. But I don’t exactly understand the timing. Does the Internal Revenue Service require these gifts to be made a year apart, or could they conceivably be made in December of one year and again in January of the next year? This is a very pressing problem for me and I cannot get either my attorney or accountant to give me an answer.--E. L. F.
A: Oh, dear. There’s no reason to get upset about this. Nor is there any reason your attorney or accountant couldn’t have given you an answer. It’s all rather simple.
As far as the IRS is concerned, what counts is the calendar year in which you make your gift. You may give $10,000 to someone in December and turn around and do it again in January; the gifts could be made a month apart or a day apart. It’s the year that counts. We hope you feel less pressed.
Withdrawing Funds From a 5-Year Account
Q: In 1987, when I was 64 years old, I rolled over a $28,000 pension payout into an individual retirement account. The account was a five-year certificate of deposit paying 8.6% interest. I remember signing a form calling for a penalty for early withdrawal. Now I am wondering if I can take all or part of my account out and transfer it into another IRA without being penalized.--S. K.
A: In all likelihood, the agreement you signed leaves you liable for an early withdrawal penalty from your savings institution should you decide to move your funds.
The reason is simply that you agreed to make a five-year investment; you cannot withdraw your funds before this investment matures. The nature and type of penalty will be set by the institution, not the government, which only imposes a penalty if you withdraw and use your IRA funds before turning age 59 1/2.
If your IRA were in a shorter-term investment or an account that permitted you access to it, you would not face this penalty. The government allows all IRA holders to move their accounts without penalty if the transaction is completed within 60 days.
By the way, the penalty you face from the savings and loan institution would be imposed regardless of whether your funds were being held in an IRA or some other type of savings account. The institution is merely enforcing the maturity date of the investment you made.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
