Real Estate Tax Laws

Tax Laws When Selling a Personal Residence

Personal Residence Exclusions

T he Taxpayer Relief Act of 1997 is the kind of people friendly legislation that becomes law all too infrequently. One of its most important provisions virtually eliminated capital gains tax on the sale of personal residences. All the 'rollover of gain into the next house' and 'once in a lifetime, over 55 exclusion' mumbo jumbo was effectively wiped out. Up to $500,000 in home profits is not taxed if you file a joint return; $250,000 if you're single.

To qualify for this exclusion you must own and use the home as your principal residence for at least two of the five years prior to the sale. You can use this exclusion every two years for the rest of your life assuming you just love to move or your job requires you to relocate.

If you're in the house for less than two years, you may have to pay tax on the entire gain unless your move is job or health related, in which case a prorated exemption is available. So be careful about this. If you have a loss when you sell your house, sorry. You can't deduct this.

Will California forcibly withhold 3 1/3% from the sale of our home?

In order to avoid withholding, you need to correctly check box 2 on Form 593-C . That question is, "Does the property you are selling qualify as your principal residence within the meaning of Internal Revenue Code Section 121?"

An issue may be the sale of a previous residence. According to §121(b)(3), the exclusion can only apply if it hasn't previously been used within two years of the current sale.

If you fail either the 24-month residency requirement or the 24-months after previous sale requirements, you might still qualify for a partial exclusion under §121(c). The conditions are explained at temporary Treasury Regulations §1.121-3T. The sale or exchange is by reason of a change in employment, health, or unforeseen circumstances. For the change of employment exception to apply, the place of new employment must be at least 50 miles farther from the residence sold or exchanged than the previous place of employment. There is another specific event safe harbor under temporary regulations §1.121-3T(e)(2)(C) that could help you. If there is a change in employment or self-employment status that results in the taxpayer's inability to pay housing costs and reasonable basic living expenses for the taxpayer's household, you may qualify for the partial exclusion.

The partial exclusion is computed by making a ratio, the numerator being the shortest of the period of time the taxpayer owned the property during the 5-year period ending on the date of the sale or exchange, or the period of time between the date of a prior sale or exchange of property for which the taxpayer excluded gain under section 121 and the date of the current sale or exchange. The numerator of the fraction may be expressed in days or months. The denominator of the fraction is 730 days or 24 months. The ratio is multiplied times the maximum exclusion amount ($250,000 or $500,000 for married, filing jointly) to determine the exclusion that applies to the sale.

If the partial exclusion applies to you, ask if a letter from a CPA or attorney stating that you qualify will satisfy the escrow company processing the withholding form. Then you can answer "yes" for box 2 and avoid the withholding.

If this approach doesn't work, you have several choices to avoid the withholding. One is to simply reduce your sales price to net zero gain. Another is to take the home off the market until you meet the 24-month residency requirement. If you need some cash, you could refinance your home or get a home-equity line of credit to tide you over this period.

I hope this helps.

However, 'better safe than sorry' is always sound advice. So here are some important tips to remember:

  1. Keep track of permanent improvements you make to the house. The list is lengthy so talk with your tax person about what qualifies or refer to IRS Publication 523, Selling Your Home. For a link go to: Home Ownership
  2. Keep the closing documents from both the purchase and sale of the house. Some of the items on the settlement statements can be used to reduce gain.

  3. The rules can be costly and complicated for those who sell a home that is used partly for business or rental purposes. Assuming your eligible to deduct a home office, you should carefully analyze whether it's still worth claiming this deduction, particularly in the two years just prior to a sale.

    Concerning home office deductions, some of the internet information from 'experts' is just plain wrong. Be cautious about wild claims. 

  4. If you previously postponed paying tax on home sale profits under the pre 1997 law, make sure you retain that information. If you're not sure, then ask your tax person or look for Form 2119 in your old returns, keying in on the year in which you sold that home.

  5. It is always possible that the tax law might change again. If the government someday needs to raise more money and decides to lower the amount of home sale profits exempt from tax, then all bets are off. Keep your records.

  6. Everyone is unhappy about withholding being required based on the selling price of real estate, but the alternatives proposed so far haven't been acceptable to the real estate industry. The State of California is dealing with a severe budget crunch and desperately needs the money. Of course, the current rules aren't "fair" and will eventually be repealed, but we have to live with them for now.

  7. If you have not deducted all the points you paid to secure a mortgage, particularly if it's a refinance, you probably will be able to deduct the remaining points as an itemized deduction in the year of sale.

  8. You typically do not report the sale of your main home in your tax return unless you have a gain and at least a part of it is taxable. If you must report a gain, do this on Schedule D.

You will probably not receive a Form 1099-S, Proceeds From A Real Estate Transaction, if you can exclude all the profits from taxation. If you receive this form, make sure you understand why. If you have it so does the IRS. Also tell your tax preparer.

As always, PLEASE make sure you read and understand the fine print. It wouldn't be taxes in America otherwise!

Real estate transfer tax

Real estate transfer tax is a tax that may be imposed by states, counties, or municipalities on the privilege of transferring real property within the jurisdiction. Total transfer taxes range from very small (for example, $1.10 per thousand in California, .01% in Colorado) to relatively large (2.2% in the District of Columbia).

Some states have a variety of transfer tax laws which may include specific exemptions for certain types of buyers based on buying status or income level (e.g. Maryland exempts certain "first time buyers" from a percentage of the total  or excludes a portion of the property's sales price from taxation altogether).

Another variation which exists is either the legal requirement to split the taxes between the parties or the local custom to do so. Thus, in Washington, DC, the 2.2% is generally split between the seller and the buyer. Prior to buying or selling, it is advisable to check with the Recorder of Deeds, a Realtor, or title company to confirm a specific jurisdiction's practices.

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