Stay in House for a Year to Please the IRS
QUESTION: I converted my primary residence to a rental property in 1983. Now I want to move back into this unit and make it my principal residence again. How long do I have to live in this house before I can sell it and defer the gain to another principal residence of equal or greater value? Does the Internal Revenue Service have any specified time period?--E. R.
ANSWER: No, the IRS does not specify a holding period for the move you propose. However, our tax experts strongly urge you to use caution so as not to arouse any suspicion that your primary reason for moving back into the house was to take advantage of the special tax deferral allowed for the sale of principal residences. Our legal and tax experts suggest that you live in your house at least a year before you put it on the market.
And they stress the “put it on the market” proviso. If you put up a “For Sale” sign the day after moving in, but don’t sell the house for a year, auditors might logically conclude that your intent all along was to sell the house and defer any gain. The auditors might also reach the same conclusion if you move your tenant out of the house but don’t actually move your belongings in. So, even though there is no specified holding period or other requirements, you would be wise to treat this house as your principal residence in every way you can.
By the way, when you actually sell the house, you must reduce your tax basis by any amount of depreciation you took on the property. Also, if you move back into the house mid-year, you must report any rental income you received during the year when you file your income taxes.
A Clarification on Child Returning Gift
Q: I’m confused. In your column last week, you discussed how a child could give back shares of stock that she had received as a gift from her parents. You said that, if the child did decide to return the stock, the tax basis of those shares would be their value when she received them. But when did she actually receive them? When they were deposited into her Uniform Gift to Minors account, or when she reached the age of majority and could legally decide how to dispose of them?--V. B.
A: The tax basis of these shares, which becomes important when the shares are sold and a gain or loss is established, is their value on the day they were initially purchased. In the original question, the parents had purchased stock over the years through a Uniform Gift to Minors account that they had established for their daughter. In this case, the date of purchase and the date of receipt by the daughter’s account are the same.
Price-Earnings Ratio Helps Measure Value
Q: Would you please define in layman’s language what “price-earnings ratio” means?--H. H. J.
A: Sure. How about this:
The price-earnings ratio of any stock is the latest per-share price divided by the last 12 months worth of earnings per share. The result of this calculation is rounded to the nearest whole number.
We got this technical definition out of a book! Could you tell? Of course; that’s probably why you asked the question to begin with. So let’s start over.
The price-earnings ratio, which is calculated by following the steps outlined above, is a measure of the relative value of a particular stock or group of stocks and is sometimes included in the stock market tables printed in your newspaper. The ratio should be considered a tool to evaluate the performance and potential of a stock and should not be confused with per-share dividends or a stock’s yield. “What you get--the dividends--and what the company keeps--the earnings--are two entirely different things,” one stockbroker is fond of noting.
Richard Roll, a professor of finance at UCLA, likes to think of the ratio as a kind of “quick and dirty” estimate of where the stock market pegs the company’s expected future earnings growth and its relative risk to investors. For example, if a company has annual earnings per share of $5 and is selling for $20 per share, its “PE,” as it’s called, is 4. A company with annual earnings of $3 per share that is selling for $30 has a PE of 10.
A high PE ratio is considered a strong signal that investors expect the company’s earnings to increase. And if a company’s PE is considerably higher than the average of its industry, you can deduce that investors have bet that the company will outperform its competitors. Conversely, a low PE is an indicator that investors believe that a stock is not expected to perform well.
Of course, there is no reason for you to believe that a particular PE ratio is an accurate assessment of a company’s future performance. The ratio is simply a measure of how the market has evaluated a company. And it’s a ratio that is based, in large part, on past performance. There are any number of savvy investors who have done quite well for themselves by following their own instincts and methods of assessing a company’s potential.
