INCOME TAXES AND YOUR RESIDENCE
By Robert A. Gustafson, CPA
Taxation of residence sales changed drastically a few years ago. In my practice, I often find that people are still unaware of these changes. While the changes benefit most people, some are left worse off.
When you sell your principal residence that you have lived in and owned for at least tow of the previous five years, the first $250,000 of gain (or $500,000 for a married couple) is free from tax. Any amounts over that are taxed at long term capital gains rates. Buying the next home no longer has any effect on tax. We are seeing people with gains in excess of these amounts, especially if they are selling in Silicon Valley or other high appreciation areas. Also, remember that once you have been out 3 years, you lose this tax free treatment entirely. People who sold before 2 years can sometimes qualify for a partial exemption.
Your gain may be bigger than you think! If you sold previous homes and deferred the gain into the next house, those previous gains now come home to roost on your current home sale. Also, “buying out” a former spouse does not add to your tax basis.
Your gain may be smaller than you think! If a spouse died while a co-owner, you may have a step-up in basis to the fair market value at death. If the property was held in a living trust or was a probated estate, the entire home is usually stepped up. If the home was held in joint tenancy, you probably only have a step-up on the decedent’s half. Steps should be taken at death to determine the value, as that may be impossible later.
If you were renting out your house, or took home office deductions after May 1997, the depreciation you previously deducted (or should have deducted) will be taxed now. Worse, if your office was in a separate building, you may owe tax on the part not treated as a residence.
There are many dangers, toils and snares in selling your home. The best advice is to discuss the whole situation with your CPA before selling.