Q: I read your article about the new tax laws ( House Structure Footings and Foundations, Description, Problems, Floors, Introduction, Sills, Columns, Beams, Joists, Subflooring ) and their benefits. It was great information and I appreciate you sharing it. I have owned a condo since 12/21/01. I am getting married and I want to sell the condo. If I sell the condo before 12/21/03 is my gains penalty still 28 percent or will it be dropped to a lower rate?
A: The capital gains on real estate are tax free for most homeowners around the country. If any tax could be considered a tax on the rich, the capital gains on real estate profits would fall in that category – at least for gains on sale of your primary residence.
Generally, the average home owner will never pay capital gains taxes on proceeds from the sale of their home. When you consider the national average price of a home lingers at about $160,000, then the average homeowner won’t even receive enough gains to tax. A single filer doesn’t owe capital gains taxes on the sale of real estate until it the gains exceed $250,000. For married filers, the floor is $500,000.
The criteria for walking away with this lottery of sorts, is two fold: the floor amount of gain ($250,000/$500,000) AND, you lived in the property at least two of the last five years – which you have.
Unless you live in an amazingly luxurious unit, I don’t see how you will gain $250,000 on your condo. Keep in mind, the cost of purchasing the house (referred to as “basis”) is subtracted from your gross gains to arrive at your gain. For example, if you purchased the condo for $200,000 and sold it for $300,000, the basis would be $200,000 (plus points paid, closing cost, etc.). To keep it simple, let’s just say it’s $200,000. Your gross receipts are $300,000 – subtract your loan amount (let’s say you’re down to $150,000) your gain is now at $150,000. Since you haven’t reached the floor of $250,000 as a single filer, you owe no taxes.
Now, you’re first reaction may be guilt – “Wait a minute, I can walk away with $150,000 tax free?” Yep. That’s the way it is. Thank you President Bush, Senior.
The thought of you selling your condo and moving into another home with your new husband has me wondering why you aren’t holding onto the condo as a rental property? Real estate is a very good investment and you get a lot of deductions as a rental that you don’t get as a primary residence. Plus, the renter is now paying the mortgage, etc., and the property could appreciate year after year, creating a nice little nest egg. Once the condo is paid off – you also have substantial passive income.
Here’s the financial scenario – you pay your mortgage now and all you get for a deduction is the interest payment and property taxes (assuming you don’t use one of the rooms as a home office – but that’s another question).
For rental properties, you deduct all the interest, property taxes, condo fees, expenses for upkeep, plus for a simple rental property, you get to depreciate it as well and this contributes to reducing your tax bill. AND, if you actively participate in the operation of the rental property – manage it in other words (accept/reject renters, call in the fix-it folks, etc.) you can deduct a limited amount of any losses from the rental activity from your other income (in other words, your day job). I’ve seen some investors end up having “losses” from their rental income and end up deducting that loss from their regular income. The depreciation alone can put you in the negative without actually depleting your cashflow.
For all the ins and outs of deductions available to rental property deductions, seek out Publication 527, Residential Rental Property (Including Rental of Vacation Homes) at www.irs.gov.
You’re probably wondering, “Well, just how much can I deduct?” Here’s the section on limits on losses from page 15 of Publication 527 under the Losses From Rental Real Estate Activities section.
“If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.”
Bottom line – hanging onto that rental property can save you tax dollars and get you and your new hubby on the road to creating wealth.