Home Is Where You Take Deduction
Q: I’m having very little luck selling my house in the current depressed market and I am being forced to relocate for my job. I am thinking of renting out the house just so I can get out of town, but I am afraid that I will lose my ability to defer any taxes on the gain if the house is no longer my principal residence. Is there anyway out of this problem? -- B.B.P .
A: As long as you continue to make an effort to sell your home throughout its rental, you should retain the right to roll over any gain from its sale to a new primary residence.
How do you demonstrate this effort to the satisfaction of potentially inquiring IRS auditors?
Clearly, you should continue to list the home for sale and show it to prospective buyers. Any rental or lease agreement you sign should be on a month-to-month basis and should contain a clear warning that the home is on the market and could be sold at any time.
Remember too that IRS requirements for deferring payment of taxes on a gain from a home sale clearly specify that the replacement home must be purchased within two years of the sale of the older residence.
The replacement home may be purchased within two years prior to that sale or within two years after the sale; the government doesn’t care. So if you purchase another home when you relocate, the two-year clock will begin ticking.
Your best bet would be to rent a new home when you relocate and give yourself the full two-year period to find a new home when you finally do sell.
Note: If you are an older taxpayer who wants to take advantage of the $125,000 exemption on home sale profits, your timetable is considerably different.
Remember that to use this onetime exclusion, you must be at least 55 and have lived in the home three of the last five years. In this case, the minute you move out of your home, the two-year clock starts running.
This time the clock is not the home replacement one, but rather the two years you are allowed to live outside the home and still count it as your principal residence.
Leasing a New Car Can Be Mighty Taxing
Q: We are currently leasing a $48,000 automobile on a three-year lease. Our payments will be in the range of $24,000. The dealer charged us a luxury tax of $1,800. Why are we paying the tax if we are not purchasing the car? Also, if the new federal tax law is retroactive to January, can we expect a refund? -- J.S.I.
A: The luxury tax was repealed--on everything but automobiles. Also, leases are considered a form of new-car financing and are subject to the luxury assessment.
Permanence Is Key to Home Improvement
Q: My home cost $140,000 and I spent $100,000 to remodel it. I added a bathroom, extended the kitchen, installed central air conditioning, replaced the roof and refinished the hardwood floors. How many of these improvements qualify for being added to my taxable basis in the home? I think I can sell the home for about $250,000. -- M.J .
A: You may add the cost of “permanent improvement” to your home’s taxable basis when figuring your potential taxable gain upon the home’s sale. The key question is what are “permanent improvements”?
Generally speaking, these are durable, long-lasting improvements that add to your home’s value or prolong its life. New plumbing, wiring or a roof qualify. So would installing a new paved driveway, swimming pool and certain types of landscaping.
Based on that criteria, our expert believes that with the possible exception of the refinished hardwood floors, all your improvements are permanent and can be included in the home’s basis. And it’s entirely possible that the hardwood floor work can qualify as well if you’re able to show that the project was more than a cosmetic change.
Painting, wallpapering and routine residential repairs do not qualify as permanent improvements. However, if these projects are completed within 90 days of selling your home, they are considered “fix-up costs” associated with the sale and may be deducted--along with the broker’s commission and other sales-related expenses--from the total sales proceeds.
After-Tax Settlement Money Is Free and Clear
Q: I recently received a settlement from my ex-husband’s retirement plan. One check was made out to the bank for a direct rollover into my IRA. The other was made out to me because the funds were after-tax. Do I have to claim the after-tax money as income? --G.W.
A: The after-tax funds are exactly what their name implies. They have already been taxed and you do not have to report them as income. The fact that the taxes were paid before your divorce is completely beside the point. What’s important is that the taxes have already been paid. Essentially, this money is free to you.
Prior Marriage Uses Up Real Estate Exclusion
Q: My husband has been married previously and has taken advantage of the onetime profit exclusion of $125,000 available to senior citizens. When we married, I had never taken advantage of my exclusion. I am wondering if I will be eligible to use my exclusion after my husband dies. -- H.L.A .
A: If you become either widowed or divorced, you are again eligible to use your $125,000 exclusion. Basically, the tax law allows everyone over 55 a onetime exclusion of up to $125,000 in profit from the sale of a house. However, once one spouse has used the exclusion, the other can’t for as long as the marriage lasts. Because your husband has already invoked his exclusion--even though it was in a prior marriage--you are not able to use yours. But if you are ever on your own again, you are free to use your exemption.
