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CAPITAL GAIN - WHAT YOU DON'T
KNOW MAY HURT YOU
Quite often Capital Gains tax is due on sale and transfer of a
real property. In 1997 tax laws were substantially modified to
provide a number of measures to allow individuals to keep more of
the profits earned when a sale occurs.
Capital Gain defined
Gain is defined by taking the net closing proceeds and
subtracting the "basis" of the property consisting of the actual
price altogether with closing cost and captital improvements which
enhance or extended the life of the property.
Rate reduction
Effective May, 2003 provided property is held 12 months
or longer the rate was reduced to 15% for all investors and
second home owners.
Sale of personal residence
Effective May 7, 1997 the home sale rollover deferral rule of code
section 1034 which provided homeowners of any age the opportunity to
defer all or part of a gain by purchasing a replacement residence
within two years before or after the sale has been replaced by a new
"universal" exclusion. Additionally code section 121 which
provided homeowners 55 or older the opportunity to exclude up to
$125,000.00 of gain from gross income by making a special one time
election was replaced.
"Universal" exclusion
The law provides that a seller of any age who has owned and used
the home as a principle residence for at least two of the five years
before the sale can exclude up to $250,000.00 from income if single
(or married filing separately) and $500,000.00 for married joint
filers.
Two year limit
In general the exclusion can only be used once every two years,
however, one's spouse's inability to use the exclusion because of
the once every two years rule won't disqualify the other spouse from
claiming the exclusion up to $250,000.00. For instance if Jane
is single and sells her principle residence in January at
$150,000.00 gain she can qualify for the home sale exclusion.
If she marries John in April and moves in his principle residence
which he has owned for ten years, he may sell the property in May
and receive up to $250,000.00 tax free.
Forced sale relief
If a taxpayer fails to meet the requirement that the property is
used two out of the last five years or fails to meet the once every
of two years rule due to a change of employment or health, they can
be entitled to a pro-rata relief. For instance, Tom sells his
principle residence after 12 months because of a new job in another
city. He may exclude 12/24ths or $125,000.00 gain on the sale
of his residence.
Other forms of relief
A surviving spouse of a deceased may "tack on" the decedents
ownership period. Similarly, an individual who receives
property incident to a divorce settlement can tack on the
transferor's holding period to their own.
Serial home strategy
Once you sell your personal residence with a zero tax bite
you are free to move into any second home or income producing
property you own and convert that property into your principle
residence (for two years out of a five year period) to qualify
for a tax free treatment up to applicable limits of $250,000.00
or $500,000.00. However if the property you are moving into
was previously part of a 1031 exchange, the holding period
for this benefit is five years.
Recapture rule
If the property you are relocating to was income producing
depreciation was taken, you are exposed to 25% tax liability on a
portion of gain upon sale. For instance, if you bought a
condominium for $175,000.00, made no improvements and deducted
$15,000.00 in depreciation, your tax basis would be $160,000.00.
Two years after converting it to your principle residence you sell
the condominium for $325,000.00, representing a $165,000.00 gain
given your $160,000.00 basis. Under the new law, capital gain
is split in two parts: the gain attributed to depreciation
previously pocketed, and the gain in resale value. The
$15,000.00 depreciation is taxed at 25% ($3,750.00) and the rest of
your gain of $150,000.00 qualifies as profit from the sale of a
principle residence escaping taxation. |
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