We Really Hate All These Complicated Tax Laws--Except When We Benefit

Q: I read your May 2 column about taxation on the sale of a home where singles are allowed $250,000 of home sale profits tax free while married couples are allowed $500,000. It is my experience that such taxation is unconstitutional because it discriminates against single homeowners. I have been a widow for 24 years and now, at 74, would like to move closer to my children, but after paying the tax bill I would not have much left to live on and have no other nest egg to face future inflation or the rising cost of health care.

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A: Let me ask you this: Are you one of those people who are constantly complaining that our tax laws are too complex? If so, think about the paradox.

We say we want a simpler tax code, but greedily accept new tax breaks that further complicate the law. We then demand fixes and refinements to those new laws, assuring full employment for a generation of auditors, tax preparers, attorneys and judges, all of whom will battle about how far those fixes and refinements should go.

That’s not to say your cause isn’t a worthy one.

The way the law stands, a widow or widower can get the full $500,000 exemption only if the home is sold in the same year the spouse died--not a time when most of us would like to contemplate uprooting ourselves.

Congress is already considering a law that would try to fix the situation, extending the full tax break to surviving spouses, though how that will work has yet to be decided.

However, even if Congress doesn’t act, you might not be facing the huge tax bill that you think.

Your home profits are based on the difference between the sale price and your “basis,” or original investment in the property plus any improvements.

When your husband died in 1975, his half of your jointly owned property received a “step up” in basis. Instead of the original investment plus improvements, his half was boosted to the fair market value of the property at that time. If you held the house as community property, then both halves of the property--yours and his--received the step up in basis.

Chances are you’ve had some pretty hefty growth in your home’s value since then. But the maximum capital gains tax on any portion of the profits that are not exempt would be 20%. While paying $50,000 tax on $250,000 of unprotected profit would be painful, you still would have $450,000 of profit free and clear (your $250,000 exemption plus the $200,000 left over after paying tax). That’s hardly chicken feed.

Gangs as Unforeseen Circumstance?

Q: My wife and I are trying to get an answer about a tax issue that has to do with the 1997 Taxpayer Relief Act. She sold a house because she was afraid to live in a gang-infested neighborhood. We’re trying to figure out if that qualifies as an “unforeseen circumstance” that would allow us to claim part of the home sale profit exemption.

I asked a tax consultant who said she spoke to two people at the IRS who gave her different answers. One said no matter what, my wife did not qualify and the other said the answer is unclear because the IRS has not published regulations on this area. This second person said that if my wife did claim the deduction, the IRS could come after her for the money if it turns out she does not qualify. This does not help; it only puts fear into my wife, and she does not know what to do.

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A: Another consequence of new tax breaks is new gray areas. Some are settled relatively quickly, when the IRS issues regulations interpreting the law or Congress passes new laws to make its intentions more clear. Others drag on for years, with auditors and judges coming to different conclusions all over the country.

Sometimes it takes a U.S. Supreme Court decision to settle an issue, and even then Congress can weigh in with laws to reverse the high court’s ruling. Witness the new law relaxing rules for home office deductions, which the Supreme Court had tightened.

You have a couple of options. You can opt not to claim the deduction now, but plan to file an amended return if the IRS settles the issue in your favor within the next three years.

Or you can go ahead and take the deduction, crossing your fingers that the IRS will either decide for you or that your return will slip under the audit radar. Chances of that are frankly pretty good: The IRS’ audit rate has dropped to generational lows as it restructures and tries to rehabilitate its image with taxpayers. If your deduction is disallowed, however, you may have to pay penalties and interest on top of the extra tax.

In this, as in all gray areas of tax law, it helps to have someone on your side who understands the law and can keep up with the various changes. It also helps if this person is on your wavelength regarding how much risk you’re willing to take.

A hot-dog accountant who loves pushing the tax envelope is not a good match for a conservative couple terrified of an IRS audit. If you’re not comfortable with the tax consultant you picked, look for another you feel you can count on.

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Liz Pulliam is a personal finance writer for The Times and a graduate of the certified financial planner training program at UC Irvine. She will answer questions submitted--or inspired--by readers on a variety of financial issues in this column. She regrets that she cannot respond personally to queries. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. For previous Money Talk questions and answers, visit The Times’ Web site at https://www.latimes .com/moneytalk.