Housing Counsel: You Own Two Units, You Pay the Tax by Benny L. Kass
Question: We own two condominium units in the same complex, but they are not adjacent to each other. We actually reside in a two-bedroom on the fifth floor. The second unit is on the second floor. That is an efficiency which we use as our office, storage for clothes and occasionally for guests. We use both spaces on a daily basis. We are considering selling both units and moving into a retirement home. Would the IRS consider these two apartments as one for tax purposes, or would we have to pay capital gains on the efficiency? Answer: You own two separate units on different floors. Because these are condominium apartments, you have two deeds and pay two real estate tax bills. Under these circumstances, I believe you will have to pay capital gains tax when you sell the efficiency. In fact, depending on your circumstances, you may also have to pay some tax on the sale of your principal residence condominium as well. Let's refresh ourselves on the law. If you have owned and used your home -- which includes condominiums and cooperative apartments -- as a principal residence for two out of the previous five years before it is sold, you can exclude up to $250,000 of profit. If you are married and file a joint tax return, the exclusion goes up to $500,000. You have admitted that the efficiency is used as your office. Furthermore, the fact that these units are not adjacent suggests that the efficiency could not qualify as your principal residence. It would be different if the units were next door to each other. Then, even though you may have used the efficiency as your office, you could abandon the office use in the year before sale, put an opening between the two units and then actually use both apartments for your own use. Most condominium documents will allow you to merge the two units physically. You will, of course, need permission from your board of directors, and that board may require that you use licensed contractors to do the construction work. In such a case, even though you will still have two deeds and pay separate real estate tax bills, a strong argument can be made that both units are, in fact, your principal residence. This would be true even if just before sale, you restore the walls separating the units, so that you can sell the two units separately. You must be careful, however, to preserve the concept that both units remain as your principal residence. I suggested earlier that you may also have to pay some capital gains tax when you sell your one-bedroom apartment. Let's look at this example. You purchased the unit many years ago for $200,000. However, you previously had a single family home which you sold before 1997. (In that year, Congress repealed the roll-over and adopted the current $250/500,000 exclusion.) You took advantage of the old "roll-over" rules, and did not have to pay tax on the $100,000 profit which you made. Although you bought your condominium for $200,000, for tax purposes, the basis of your unit is really $100,000 ($200,000 minus $100,000). Because of the significant appreciation that condominium units have had in recent years, you believe you can sell that unit for $650,000. Thus, for tax purposes, you will make a profit of $550,000 ($650,000 minus $100,000). Since you and your wife can shelter up to $500,000 of this gain, you will still have to pay tax on the $50,000 excess. At the current federal tax rate of 15 percent, this means that you will have to pay Uncle Sam $7,500, plus the applicable state tax . Obviously, all expenses associated with the sale, such as real estate commissions or transfer taxes, will reduce your profit and thus lower any tax you may have to pay. But hey! You made a lot of money, and should not complain too much about having to pay this small amount of tax. If you have to pay tax, there are several ways to defer this obligation: |
