Avoid Being Charged Interest--Pay Capital Gains Taxes on Home Sale Promptly

Q If you sell your home for a profit and do not know whether you will buy another home, are you better off paying the capital gains taxes immediately or waiting until the two-year replacement period lapses? Does the government charge you interest on the capital gains tax that should have been paid in the year the home was sold? What about state taxes?

-- G.D.S.

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A Here’s the most important fact you should know when trying to decide how to fill out your tax form: Uncle Sam and the state of California will charge you interest on any capital gains taxes you owe from the sale of your house if you do not buy a replacement home of equal or greater value within 24 months.

This should help you decide whether to pay the taxes immediately or wait. If you think there is a strong likelihood that you will owe capital gains taxes from your home sale, you are better off completing IRS Form 2119 and paying the government as soon as you have to. Otherwise, you face paying the government far more in interest than you would probably earn on the money if you invested it.

If it turns out that you don’t owe the government any money and you’ve already paid, you can always file an amended return and seek a refund. However, as you might expect, even though the government charges you interest on owed back taxes, it does not pay you interest on any overpayment.

If you believe that you will buy a replacement home of equal or greater value within the allowed two years, you can wait to report the gain and subsequent new-home purchase. However, you still must report the sale for the tax year in which it was made.

Reporting of Early IRA Disbursement Q My husband and I withdrew $15,000 from our individual retirement accounts at our stock brokerage to help buy a home. I know we will have to pay taxes on this money as well as a penalty for early withdrawal, but I don’t know how this will get reported to the Internal Revenue Service. Can you explain?

--T.C.

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A The process is not much more complicated than filling out your annual tax form and writing a check. Your broker will send you a Form 1099 noting you sold the stock from your IRA and the amount you received from the sale. A copy of this is sent to the IRS and to the state.

In preparing your federal tax return, you should complete Form 5329 to report that you owe a penalty for a premature distribution from your IRA. For your state tax return, be sure to complete and file Form 3805P.

Another important matter to consider when making a premature withdrawal from an IRA is withholding tax. If your broker or IRA trustee does not withhold any taxes from your distribution, you could face additional penalties from the state and federal governments for failing to prepay sufficient taxes on your income for the year.

State and federal penalties are assessed when taxpayers fail to prepay either 90% of the taxes they will owe for the year or an amount equal to their tax obligation for the previous year.

If taxes were not withheld from your IRA withdrawal, our tax experts say you can make up for this and avoid any tax penalty by increasing the amount in taxes you have withheld at work.

Although the taxes may not have been withheld in the quarter the IRA withdrawal was made, the government will overlook that and accept a final-quarter prepayment. (Unfortunately, this procedure doesn’t apply to individuals filing estimated tax returns.)

Although prepaying additional taxes now is bound to cut into your income for the remainder of the year, the alternative could be a stiff tax penalty. And you should try to avoid that, especially because you are already paying a 10% penalty for having withdrawn your IRA funds early.

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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 e-mail to carla.lazzareschi@latimes.com