Home Seller Faces Tax Dilemma
Q. We sold our principal residence 23 months ago with the hope that construction on our new home would be completed within the 24-month limit the Internal Revenue Service imposes for the tax-deferred reinvestment of profits from a home sale. Unfortunately, the home is nowhere near completion. Our tax adviser says not to worry because the IRS rarely polices this aspect of the tax return. Is this true? How safe is it to act as though the profits were reinvested within the time limit?
--A.W.F.
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A. How safe is it to cheat on your taxes? Is that what you’re really wondering?
Here’s what the IRS says: Taxpayers selling a home are required to file Form 2119 for the year in which they sell their home. This form notes the sale price and allows the taxpayer to check a box indicating that the proceeds will be reinvested in a home within the 24-month limit. When you purchase and move into a replacement home of equal or greater value than the one you sold, you are supposed to file an amended Form 2119. However, if the purchase price of the replacement home does not at least equal the adjusted sale price of the old home, or if you do not move into your replacement home within 24 months of selling the old home, you are supposed to file an amended return on Form 1040X for the year of the sale and attach a new Form 2119 and Schedule D. You must pay the taxes due plus interest on that amount.
How does the IRS police this? Pretty much as it does the rest of the Tax Code: with the threat of legal duress and steep financial penalties upon discovery.
Your accountant has probably told you that the IRS doesn’t routinely look for missing Form 2119 amendments. And that’s apparently been true.
In the best of worlds, you’d be taking a big chance; in the worst, you’d be caught and penalized. Instead you might consider talking to your local municipal building department to see if you can qualify for some sort of occupancy permit on your home within the 24 months. Our accounting sources say that if your house is close to completion and you are under the gun, you might be able to get an occupancy permit that will satisfy the IRS.
Proper Reporting Will Avert Problems
Q. I will turn 65 in July. My wife is 18 years younger. We are self-employed and in an informal partnership. We each have our own clients and specialties. Client payments are made to each of us individually. We submit a joint tax return and report our income without distinguishing between what is hers and what is mine. She typically brings in about 60% to 70% of the income.
When I begin drawing Social Security benefits, how can I ensure that only my income, rather than half our joint income, is charged against the maximum that I can earn before my Social Security benefits are reduced?
--D.R.
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A. If the situation is really as you state, with your wife as the major breadwinner, you should have been reporting your respective partnership incomes correctly to the Internal Revenue Service all along to avoid the very situation you now face: a potential loss of Social Security benefits because of excess earnings.
Unfortunately, switching the method of reporting your respective partnership shares at this juncture could raise suspicions that you are suddenly allowing your much younger wife to claim the lion’s share of the partnership income to avoid Social Security earnings limits on your true share.
That said, the Social Security Administration says that for you to avoid overstating your income, the partnership should compute its net earnings from self-employment using IRS Form 1065. Then the two of you should determine how the net profit or loss is to be divided between you. Usually, it is a 50-50 split, but in cases where one partner has provided an unequal share of the capital, time or value of services, the split should reflect that apportionment. The individual shares of profits or losses should be reported by each partner on Form 1065, Schedule K. Then each partner should report his or her partnership income along with any other self-employment income on Schedule SE. This will assure the posting of correct self-employment income to each partner.
You should know that in your case, you may file amended tax returns going back as many as three tax years. The Social Security Administration can then make any necessary corrections.
By the way, for 1996, Social Security recipients under age 65 lose $1 for every $2 they earn over $8,280 per year, and recipients over age 65 lose $1 for every $3 they earn over $11,520. There are no earned-income restrictions on recipients over 70. These earned-income limits are applied to the family’s total Social Security benefits, not just the wage earner’s. Thus, if a husband or wife is drawing spousal benefits, those will be reduced as well if the earned-income limits are exceeded.
* Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or Send electronic mail to carla.lazzareschi@latimes.com
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Helpful Hints on Treasury Securities, Social Security
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