Home sweet home: ascertaining the tax basis of a personal residence.EXECUTIVE SUMMARY
* As home prices escalate and the IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. gain exclusion remains stationary, the potential for taxable gains Taxable Gain
The portion of a sale that is liable to taxation.
When redistributing mutual fund shares that have increased in value, returns may be subject to taxation.
See also: Capital gain, Income Tax looms ever larger. It's important to know the tax basis in your home and keep accurate records.
* The initial tax basis includes the cost of the home plus all settlement and closing costs Closing Costs
The numerous expenses (over and above the price of the property) that buyers and sellers normally incur to complete a real estate transaction. Costs incurred include loan origination fee, discount points, appraisal fee, title search, title insurance, survey, taxes, .
* Home improvements-such as construction of an addition or installation of a pool-give rise to basis increases.
* Deductible casualty losses; payments received for granting an easement easement, in law, the right to use the land of another for a specified purpose, as distinguished from the right to possess that land. If the easement benefits the holder personally and is not associated with any land he owns, it is an easement in gross (e.g. : and residential energy and first-time homebuyer First-Time Homebuyer
An IRA owner who is exempt from the early-distribution penalty (which applies to IRA distributions that occur before the IRA owner reaches age 59.5) for distributing funds from his or her IRA to buy, build, or rebuild a home when having had no interest in a credits may result in taxpayers' reducing the tax basis in their homes. Homeowners who use their homes for business or rental use and who depreciate depreciate v. in accounting, to reduce the value of an asset each year theoretically on the basis that the assets (such as equipment, vehicles or structures) will eventually become obsolete, worn out and of little value. (See: depreciation) a portion of their home also must reduce basis accordingly.
* Generally, keep tax returns, worksheets and forms for three years. Keep any records relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc property longer, as they are relevant for determining basis.
Home prices have skyrocketed over the past few years, but the exclusion afforded to taxpayers by IRC section 121 has not kept pace with the surge. This part of the tax code excludes the first $250,000 ($500,000 in the case of joint filers) of home sale gain from tax if certain conditions are met. But Congress did not index these exclusion figures for inflation.
As home prices escalate and the IRC section 121 exclusion remains stationary, the potential for taxable gain looms ever larger. This article thus explores the general tax roles associated with home ownership and suggests ways taxpayers can minimize their gains when selling their homes.
RULES REGARDING HOME SALES
In general, taxpayers recognize all gains on the sale of property, including homes. Because a home does not fall within any of the exceptions to capital asset classification, any gain arising from a sale is subject to preferential capital gain rates. To promote home ownership and in recognition of the difficulties of ascertaining a home's tax basis, Congress has traditionally offered homeowners numerous tax benefits.
Under current law, taxpayers can exclude from income the first $250,000, or $500,000 in the case of joint filers, of gain on the sale or disposition of a personal residence. For this exclusion to apply, however, two conditions must be met. First, the property must be the taxpayer's principal residence (that is, the property the taxpayer occupies the majority of the time). Second, the taxpayer must have owned and used the property as a personal residence for two or more years of the five-year period ending on the date of the sale of the property.
The exclusion of the gain from income under IRC section 121 is not a one-time offer. Taxpayers can use it every two years, as long as they've met both the required conditions. If a taxpayer has experienced a change of employment or health or when certain other unforeseen circumstances arise (for example, involuntary conversion of the residence), this two-year limitation rule is relaxed under IRC section 121(c)(2).
Even a cursory cur·so·ry
Performed with haste and scant attention to detail: a cursory glance at the headlines.
[Late Latin curs reading of IRC section 121 reveals that when Congress instituted it, the intent was to exclude the vast majority of personal residence gains from tax. But even a decade ago, Congress did not anticipate how quickly home prices would escalate. Now, with a federal budget awash Awash (ä`wäsh), river, E Ethiopia, rising near Addis Ababa and flowing c.500 mi (800 km) to a swampy lake near the Djibouti border. The Awash Valley is important agriculturally and has hydroelectric plants. in deficits, there is little discussion in Washington about raising the IRC section 121 exclusion figures or indexing them for inflation (though President Bush's Blue Ribbon blue ribbon
denotes highest honor. [Western Folklore: Brewer Dictionary, 127]
See : Prize Tax Reform Panel recently recommended raising the exclusion to $300,000 for single taxpayers and $600,000 for married ones filing jointly). Thus, it is more important than ever for taxpayers to accurately track the tax basis in their homes.
COMPUTING TAX BASIS
Like any other investment a taxpayer makes, a personal residence has an initial tax basis that fluctuates over time. First, let's examine the computation of the initial tax basis; then we'll explore the nature of adjustments to this basis.
Initial tax basis. The usual supposition under IRC section 1012 is that cost represents the taxpayer's initial tax basis. If the taxpayer rolled over a prior home-sale gain under pre-1997 law, the taxpayer's initial cost basis must be reduced by this unrecognized gain.
Other items also factor into the initial tax basis---including all settlement and closing costs (Treasury regulations section 1.212-1(k)). IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. Publication 523, Selling Your Home, offers the following examples of such costs: abstract fees; charges for installing utility lines; legal fees (including fees for the title search and preparing the sale contract and deed); recording fees; survey fees; transfer taxes; owner's title insurance; and any amounts the seller owes that the buyers agree to pay, such as certain real estate taxes, back interest, recording or mortgage fees, charges for improvements or repairs, or sales commissions.
Personal living expenses are not included. IRS Publication 523 cites the following items related to settlement and dosing costs as personal living expenses that are not added to the basis: fire insurance premiums, rent for occupancy of the house before dosing, charges for utilities or other services related to occupancy of the house before dosing, any fee or cost that a taxpayer deducts as a moving expense, charges connected with getting a mortgage loan and fees for refinancing a mortgage.
Special basis rules apply if a taxpayer receives a personal residence as a gift, bequest bequest: see legacy. or payment for services rendered. In the case of a gift, the taxpayer's basis in the house generally is equal to the donor's basis (IRC section 1015(a)). In the case of bequests, the basis generally is equal to the fair market value at the date of the decedent's death (IRC section 1014(a)). And in the case of compensatory transfers, the basis is generally equal to the fair market value on the date of transfer (Treasury regulations section 1012-1(a)).
Adjustments to basis. Some expenditures and circumstances are nonevents for tax purposes and some will give rise to basis adjustments. The cost of repairs that maintain the good condition of a home but do not add to its value or prolong its life--such as exterior and interior painting, blacktop sealing or chimney cleaning--do not get added to the tax basis. Home improvements, such as construction of an addition or installation of a pool, do increase the tax basis (IRC section 1016(a)).
Several circumstances may cause homeowners to reduce the tax basis they have in their homes, including deductible casualty losses (or insurance payments related thereto); payments received for granting an easement or right-of-way; and residential energy, adoption and first-time homebuyer credits. Taxpayers who use their homes for business or rental and who depreciate a portion of their homes also must reduce the tax basis accordingly. Finally, taxpayers who remove improvements from their homes must reduce the tax basis by the basis they had in these improvements (see, for example, Bayly v. Commissioner, TC Memo 1981-549).
To illustrate the mechanics of computing a tax basis, let's consider the example of Jay and Kay In 1998 they purchased a house for $300,000 and incurred $20,000 in closing costs. In 1999, they built a three-room addition to the house for $30,000; in 2000, they had the house painted for $5,000; in 2001, they were paid $50,000 for a conservation easement going over a portion of their land; and in 2002, they razed raze also rase
tr.v. razed also rased, raz·ing also ras·ing, raz·es also ras·es
1. To level to the ground; demolish. See Synonyms at ruin.
2. To scrape or shave off.
3. one of the three rooms they had built in 1999. Finally, in 2005, Jay and Kay sold the house for $900,000.
Here's how they would compute their tax basis:</p> <pre> Purchase price $300,000 Closing costs 20,000 Initial Cost Basis
320,000 Cost of three-room addition 30,000 Painting (repair)
0 Easement (50,000) Removal of one room (10,000) New Adjusted Basis $290,000 </pre> <p>Since their current basis in the home is $290,000, Jay and Kay would realize a $610,000 gain ($900,000-$290,000). After accounting for the $500,000 exclusion under IRC section 121, the couple would owe capital gains tax on the remaining $110,000 of gain ($610,000-$500,000).
SUBSTANTIATING TAX BASIS
The government has made clear the importance it attaches to basis records. The Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq. imposes an obligation on taxpayers to "keep such records as the Secretary of the Treasury may from time to time prescribe," and the relevant Treasury regulations echo this sentiment. The instructions to form 1040, under "How Long Should Records Be Kept?" in the "General Information" section, state that "tax returns, worksheets and forms should be kept for three years, but records relating to property should be kept longer insofar in·so·far
To such an extent.
Adv. 1. insofar - to the degree or extent that; "insofar as it can be ascertained, the horse lung is comparable to that of man"; "so far as it is reasonably practical he should practice as they are relevant for determining basis." IRS Publication 552, Recordkeeping for Individuals, also says "everybody should keep" basis records for their homes.
Taxpayers should retain proof of their home's purchase price and other records that document the costs of improvements, additions and other items affecting the home's adjusted basis not just for three years (the traditional retention period for tax records), but rather for the entire span of home ownership plus an additional three years from the point of sale. While tax returns generally need to be retained for only three years, it is prudent to hold onto returns for which a form 2119--related to tax-free rollovers under prior law--was filed because this form shows any postponed gain on residence sales made before May 7, 1997. In case of an audit, producing originals or photocopies of these salient documents can prove invaluable.
What are the tax consequences of failing to keep good records? Some taxpayers believe that absent written documentation tax basis is deemed to be zero, but this is not exactly correct. The governing rule, having its genesis in the frequently cited Cohan v. Commissioner decision, essentially is that taxpayers can make offers of proof relating to the issue of basis, but the courts are at liberty to construe construe v. to determine the meaning of the words of a written document, statute or legal decision, based upon rules of legal interpretation as well as normal meanings. the proffered evidence in the light least favorable to the taxpayer.
Several courts have applied the so-called Cohan rule. In some cases taxpayers offered only their own oral recollections and rough estimates (see Bayly v. Commissioner); in others they had some corroborating evidence corroborating evidence n. evidence which strengthens, adds to, or confirms already existing evidence. such as bills and documentation relating to mortgage loans (see Cenedella v. Commissioner); and in still others, they were able to show before and after improvement photographs of their homes (see Estate of Gunther v. Commissioner). In each of these cases, the courts relied heavily upon the Cohan rule; that is, they granted taxpayers some leeway lee·way
1. The drift of a ship or an aircraft to leeward of the course being steered.
2. A margin of freedom or variation, as of activity, time, or expenditure; latitude. See Synonyms at room. in proving the tax basis in their homes but gave virtually all benefits of the doubt to the government.
FOUR KEY STRATEGIES
There is a simple axiom in the income tax system: For every extra dollar of tax basis an asset has, there is one less dollar of gain to recognize or one more dollar of tax loss to report. While the tax-loss side of this equation does not apply in the context of home sales, due to the disallowance dis·al·low
tr.v. dis·al·lowed, dis·al·low·ing, dis·al·lows
1. To refuse to allow: "[The government] rule for transactions that are not entered into for profit, the minimization-of-gain aspect has tremendous relevance. Every time taxpayers make purchases related to their homes, prudence requires they bifurcate To divide into two. such outlays as either expenses or improvements. Taxpayers should keep careful records of the latter category to minimize their gains.
Taxpayers also should pay particular attention to four key strategies.
* IRC section 121 can be capitalized upon every two years. So rather than retaining title to their homes over several decades, taxpayers should consider selling their homes every few years and using IRC section 121 to shield their potential gains. Holding a home over a shorter period of time lessens the prospects that its appreciation will exceed the current IRC section 121 thresholds, even if home prices increase rapidly
* Elderly taxpayers should think twice before gifting their homes. Many do this as a form of Medicaid planning (that is, to divest To deprive or take away.
Divest is usually used in reference to the relinquishment of authority, power, property, or title. If, for example, an individual is disinherited, he or she is divested of the right to inherit money. themselves of assets in order to qualify for Medicaid). There are two flaws in this approach. First, recipients who receive title to the property in question also receive the taxpayers' basis in such property, which is usually quite low. Second, when title to the home is then sold, the taxpayers who received this gift often do not qualify for IRC section 121 relief because they don't meet the two-year personal use requirement. The result is usually large--and unexpected--taxable gains. Had the elderly taxpayers retained title to the home in their names, could have eliminated the gains largely via the basis-equals-fair-market rule applicable upon death (see IRC section 1014(a)).
* Taxpayers who own both a personal residence and a vacation home Vacation Home
A home separate from an individual's primary residence that is used for recreational purposes and may also be rented out at unused times.
For tax purposes, those who rent their vacation homes may result in a lower amount of allowable expense should carefully consider their strategy for selling these properties. If the ownership of their personal residence meets the qualifications of IRC section 121, they should sell their personal residence first and command the benefit of the IRC section 121 exclusion. Then they should make their vacation home their primary residence and live there for two years. Once they have met this residency requirement, they can sell their erstwhile erst·while
In the past; at a former time; formerly.
Former: our erstwhile companions.
Adverb vacation home and once again take advantage of the IRC section 121 exclusion.
* Sometimes taxpayers exchange property that satisfies the requirements for both the exclusion of gain for a primary residence under IRC section 121 and the nonrecognition of gain on the exchange of like-kind properties Like-Kind Property
Investment or business land/properties that are considered to be the same type and exchanging them is therefore tax-free.
For example, you can exchange a car for another car tax-free, but not a car for a piece of land. under IRC section 1031. This may happen in one of the following contexts: when taxpayers meet the ownership and residency requirements of IRC section 121 and subsequently rent the same property as part of a trade or business or when taxpayers use part of the property as their personal residence and another part of it in a trade or business, say as a home office.
Revenue procedure 2005-14 explains the implications when such mixed-use property is exchanged for like-kind property, generally allowing taxpayers to simultaneously capitalize on Cap´i`tal`ize on`
v. t. 1. To turn (an opportunity) to one's advantage; to take advantage of (a situation); to profit from; as, to capitalize on an opponent's mistakes s>. the exclusion IRC section 121 affords and the deferral deferral - Waiting for quiet on the Ethernet. offered by IRC section 1031.
Let's consider a simple example in which Mary, an unmarried taxpayer, buys a house for $210,000 and uses it as her principal residence from years one to five. From years five to seven, she rents the property to a tenant and claims depreciation deductions of $20,000. The house qualifies as a personal residence under IRC section 121 and as trade or business property under IRC section 1031(a). The house has an adjusted basis of $190,000 ($210,000-$20,000).
If Mary exchanges the house for $10,000 of cash and a townhouse town·house or town house
1. A residence in a city.
2. A row house, especially a fashionable one. with a fair market value of $460,000 that she intends to rent to tenants, she realizes $470,000 on the exchange (that is, $10,000 cash plus the fair market value of the townhouse). After subtracting the $190,000 adjusted basis in the house from the realized gain Realized Gain
A gain resulting from selling an asset at a price higher than the original purchase price.
There may be tax consequences for a realized profit. , Mary recognizes a $280,000 gain ($470,000-$190,000). She can exclude $250,000 of the gain recognized under IRC section 121 and defer the remaining $30,000 of gain recognized under IRC section 1031. Her basis in the replacement property is $430,000: the basis of the relinquished property at the time of the exchange ($190,000) increased by the gain excluded under IRC section 121 ($250,000) and reduced by the cash she received ($10,000). Revenue procedure 2005-14 offers several other more complex examples detailing the benefits and the interplay IRC sections 121 and 1031 offer.
When it comes to the tax basis in one's home, taxpayers have many arrows in their tax-planning quivers. They must be careful, however, to aim carefully at the intended target: a reduction of their capital gain income.
HOUSING PRICES JUMP
According to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. the National Association of Realtors The National Association of Realtors (NAR) is made up of residential and commercial realtors who are brokers, salespeople, property managers, appraisers, and counselors, and others working in the real estate industry. (www.realtor.org), the median U.S. home price jumped to $218,000 in October 2005, up 16.6% over 2004 and 55% over 2000.
* Practical Tips
* Be sure clients keep a journal of their home purchases closing expenses and record adjustments and all related receipts and records.
* Consider capitalizing on IRC section 121 by selling your personal residence every two years.
* Advise elderly clients to think twice before gifting their homes.
See American Institute of Certified Public Accountants (AICPA). RESOURCE
CPE (Customer Premises Equipment) Communications equipment that resides on the customer's premises.
CPE - Customer Premises Equipment
2005 Individual Tax Returns videocourse (DVD/text/manual, # 113606JA; VHS/text/manual, # 113607JA).
* IRS Publication 523, Selling Your Home. www.irs.gov.
* IRS Publication 552, Recordkeeping for Individuals. www.irs.gov.
Leonard Goodman, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , PhD, is professor of accounting at Rutgers University Rutgers University, main campus at New Brunswick, N.J.; land-grant and state supported; coeducational except for Douglass College; chartered 1766 as Queen's College, opened 1771. Campuses and Facilities
Rutgers maintains three campuses. , New Brunswick New Brunswick, province, Canada
New Brunswick, province (2001 pop. 729,498), 28,345 sq mi (73,433 sq km), including 519 sq mi (1,345 sq km) of water surface, E Canada. , N.J. His e-mail address See Internet address.
e-mail address - electronic mail address is goodman@ business.rutgers.edu. Jay A. Soled, JD, LLM LLM
Latin Legum Magister (Master of Laws)
LLM Master of Laws [Latin Legum Magister]
Noun 1. , is an associate professor of taxation at Rutgers University in Newark, N.J. His e-mail address is firstname.lastname@example.org.