We’re all familiar with soaring home prices. In addition to the normal moves associated with life changes, this has many people wondering if now is the time to sell. We’ve had a number of calls from clients asking about the tax consequences of a residence sale.

First, what constitutes a personal residence? It’s where you live the majority of time – true fixed and permanent home. There are factors to consider such as where is your job, mailing address, driver’s license.  It does not have to be a single-family dwelling – can be a trailer, houseboat, mobile home or condominium apartment. A home in a retirement community qualifies if it’s an equity interest.  A second home does not qualify although after selling your primary residence it could become your principal residence.

In general, if you’ve owned the home and used it as you’re your personal residence for two (2) of the of the last five (5) years a married couple can avoid tax on up to $500,000 of gain ($250,000 if single).  Obviously, if you meet the residence test and sell a home for $500,000 or less (married filing jointly) it is basically impossible to have a taxable gain.

To determine the gain or loss you need to determine basis – which is cost plus any improvements. Improvements are items with a useful life exceeding one year – like a fence, addition, roof, wiring or plumbing upgrades. Also, if you deferred gain under the old home sale rules before May 7, 1997, the deferred gain reduces your basis. Painting or fixing a leaky roof are considered repairs not improvements. Basis is stepped up to fair market value at death.

What if you sell before meeting the 2- year ownership and use test? There are exceptions which allow you to take a percentage of the exclusion and possibly exclude some or all of the gain. They are:

• A change in employment. The IRS provides a safe harbor based on distance. If the new place of employment is 50 miles farther from the home sold than the old place of employment.
• Sale due to health issues. If home is sold to facilitate medical treatment or house will no longer accommodate the homeowner due to illness or an injury. A physician’s recommendation automatically qualifies for IRS safe harbor. Get in writing and store with tax documents.
• Unforeseen circumstances – destruction of a home in a storm or fire, death, divorce, most any circumstance that left the homeowner unable to financially maintain the home.

What if you have a loss on the sale of your residence? The loss is not deductible. The exception would be if the residence was converted to a rental property and then sold. The IRS and Tax Court have taken taxpayers to task so beware if that’s your strategy and have proper support for your position.

Even if you are not currently planning to sell it’s important to maintain documentation to calculate and support your basis – who knows what the rules might be 10 or 20 years from now. We recommend keeping a file – paper or electronic. Start with a copy of the closing statement for the purchase. Next, include documents to support any additions. Say you add a deck – keep the contract, invoices and also check copies to substantiate payment. Better too much documentation than not enough.

These rules seem simple and straight forward.  The truth is the real world is messy and there are many situations beyond the scope of this article.  If you have questions, please contact your DentMoses advisor.