So far this year the economic news has been less than thrilling. With the stock market rising and falling, the prospect of war looming and an economic package that's accomplished little more than stimulate conversation, this winter's discontent runs deeper and colder than usual.
But for the grace of the gods at the IRS, our humility can become more sanguine for those who are contemplating selling their home in an area where values have appreciated significantly.
Rules issued at the end of 2002 clarifying the when and the extent to which homeowners can take tax exclusions of up to $500,000 and reduce their capital gains taxes when they sell their homes have at long last been codified. New rules have been established to clarify the deductibility of a vacant portion of land that was formerly part of a principal residence and how the gain can be divided between residential and business use.
In addition, soon-to-be-finalized rules will allow homeowners to qualify for reduced exclusions if they move from the residence before the mandated two years are up — provided there are unusual circumstances such as a job loss, a family health condition or a divorce or legal separation. (For more information, check out the final and temporary provisions, Treasury Decision 9030 and Treasury Decision 9031, respectively, at www.irs.gov.)
The law as it was written in 1997 allowed a homeowner to exclude from taxation up to $250,000 in gains or up to $500,000 for married couples filing for a principal residence as long as they lived in the house for at least two of the last five years. Now with the issuance of these long-awaited guidelines, accountants and homeowners will have a better understanding of how the IRS will treat capital gains taxes that most people simply paid out of fear of not qualifying. What makes these provisions even tastier is that they're retroactive. IRS form 1040X allows taxpayers to amend their returns for up to three years from the date of the original return.
(A 1999 return can be amended until April 2003.)
For those with multiple homes, several new rules have been established that will assist in establishing which property will be considered the principal residence. They include where you spend most of your time, which home is noted on your tax returns, car license and driver and voter registration and how far the dwelling is from your place of employment.
If you're selling a vacant portion of land that was part of your principal residence, you can now include the gain from that sale if it occurs within two years before or after the sale of the house.
For those of you who use your home as a primary residence as well as a business office, it will no longer be necessary to separate the gains between residential and business use if both occurred under the same roof. This change could result in a lower tax bill, since a homeowner can now claim a greater exclusion on a gain.
To illustrate this, I simply quote from and draw from IRS summary. Assume that you bought your house and the property it stands on for $100,000 10 years ago — about $20,000 of the price was for the land and $80,000 for the house. For the past five years, you've been running a business from about 20 percent of your home, taking deductions of $410.26 a year (one-fifth the price of the $80,000 house divided by 39 years, the IRS depreciation schedule for business property). So over the past five years, you've taken a total of $2,051 in deductions.
Now the value of your house and property have tripled to $300,000, and you're considering selling it. Your capital gains are $200,000, all of which is excludable. That means you don't even have to report this transaction on your tax returns. But the $2,051 that you've deducted as depreciation over the past five years will be "recaptured" and taxed as ordinary income.
On the other hand, under the old regulations you would have had to first allocate 20 percent, or about $40,000, of the $200,000 capital gains to business use. Of this amount, $160,000 would have been excluded from taxation and $2,051 (the deductions taken for depreciation) would have been taxed as ordinary income while $37,949 would have been taxed as capital gains.
To round out the blessings bestowed upon us by the happy, friendly folks at the IRS, homeowners can sell the house and claim a reduced exclusion in the event of "multiple births resulting from the same pregnancy," as this situation is likely to result in the need for more living space. Oh, I can see it now: "Hey honey, remember that bigger house we were talking about but concluded we could not afford well according to the IRS if...?"
Anyway, who would have thought that a visit to the gynecologist could lead to an immediate consult with an accountant (which is a must if you want to do it right and particularly if you're contemplating taking advantage of any the above provisions)?
THIS WEEK'S TIP: Does the Chandelier Stay? (Part 2)
In contrast to real property, personal property is those items that are moveable and can be easily removed from the property without damaging it. This might seem fairly clear-cut and indisputable, but problems do arise when one party considers an item, such as chandelier, personal property and the other party considers it a part of the home and real property.
The law specifies several criteria for determining whether an item is considered real or personal property. It looks at the intention and the manner in which the item is attached to the property in order to determine if the item is a fixture. The intention of the owner at the time of installation might be hard to determine, so it's important at the time of the sale that the personal property items are listed in the purchase agreement between the buyer and seller. Any items of questionable intention should be listed, which will transfer ownership of the personal property items.
It's advisable to list any light fixtures that might be in question in a list of personal property items which will either stay with the property or be removed by the seller. Mirrors, appliances, water softeners and built-in bookshelves should also be listed in the contract.
Personal property items such as furniture don't generally present a problem, as these items aren't typically fitted or attached to the property. Items which are attached to the property that can't be removed without doing damage to the real estate are generally considered to be part of the real property. Such items as drapes, blinds and other window coverings might present a problem when the intention of the parties isn't made clear.
The best way to avoid any confusion at closing is to make a list of the personal property items that will be included in the sale and have all parties sign the document
Home Work is a weekly column geared toward residential real estate.