Ask Liz Weston

Get smart with your money

Real Estate

Q&A: Capital gains tax

By

Dear Liz: I am selling my house. After subtracting all selling costs, stepping up the basis for capital improvements over the years, and using the $500,000 capital gains exclusion from the IRS, I will still have a significant capital gains tax due. Does this tax need to be paid via the quarterly estimated tax in the quarter the house closes, or can I wait and pay the capital gains tax with the yearly tax filing?

Answer: If you are the sole owner of the home, then you can exclude up to $250,000 of capital gains from a home sale. If you’re married then the exclusion amount is doubled to $500,000.

Ours is a “pay as you go” tax system, which means you’re supposed to withhold the appropriate taxes as you earn or receive income. If you don’t withhold enough, you can owe penalties. People who don’t have regular paychecks or who experience windfalls, such as your home sale, may have to make quarterly estimated payments to ensure they’ve paid enough to avoid the penalties.

One way to avoid penalties is to make sure your 2022 withholding at least equals your 2021 tax bill, if your adjusted gross income is $150,000 or less. If your adjusted gross income is more than $150,000, your withholding needs to equal 110% of your 2021 tax bill. Another is to pay 90% of your 2022 tax bill. It’s tough to know what your tax bill is going to be before the year ends, though, so most people choose to withhold based on their 2021 tax bill. If your 2022 bill will significantly exceed your withholding, however, you’ll want to make sure you stash the appropriate cash in a safe, FDIC-insured savings account so it’s available when you have to pay Uncle Sam next year.

Q&A: How previous home sales might affect your capital gains taxes

By

Dear Liz: I am selling my house and will not be buying another one. I believe that I know the rules of capital gains taxes in general. However, must I include the capital gains of previous homes, even those experienced many years ago?

Answer: Possibly.

Before 1997, homeowners could avoid capital gains taxes by rolling their profits into another home, as long as the purchase price of the new house was equal to or greater than the home they sold. Homeowners 55 and older could get a one-time exclusion of up to $125,000.

The rules changed in 1997. Now homeowners can exclude up to $250,000 of home sale gains as long as they have owned and lived in the home at least two of the prior five years. A married couple can exclude up to $500,000.

If you have not sold a home since the rules changed, however, any previously deferred gains would lower the tax basis on your current home.

Let’s say you bought your current home for $300,000 prior to 1997. Normally, that amount (plus certain other expenses, including qualifying home improvements) would be your tax basis. If the net proceeds from your sale were $500,000, for example, you would subtract the $300,000 basis from that amount for a capital gain of $200,000.

But now let’s say you rolled $200,000 of capital gains from previous home sales into your current home. That amount would be subtracted from your tax basis, so your capital gain would be $400,000 — the $500,000 net sale proceeds minus your $100,000 tax basis.

Before selling any home, you should consult with a tax pro to make sure you understand how capital gains taxes may affect the sale. You don’t want to find out you owe a big tax bill after you’ve spent or invested the proceeds.

Q&A: Homeownership and taxes

By

Dear Liz: Five years ago I co-signed on a mortgage for my daughter’s condo in another state. I provided the down payment and paid to upgrade the water, HVAC and kitchen appliances. She paid the mortgage and all other expenses. She also claimed the mortgage interest on her taxes every year. She just sold the condo and is moving to another state. The net proceeds will mostly be used for the down payment on the next property. My name will not be on that one. She will pay me back for the down payment in installments.

I’m aware that the year a property is sold is the only time to claim the upgrades for a deduction. I haven’t been claiming any part of the condo in the last five years. Is there some way to do that on my 2022 taxes? Or should she take the deduction and pay me back in more installments down the road? Obviously, I don’t want to make a claim that will hurt her 2022 taxes, but it would be nice to recoup some of it.

Answer: Home improvements on a personal residence aren’t deductible. If your daughter had paid for the upgrades, she could use the cost to reduce the amount of home sale profits that might otherwise be subject to capital gains taxes. These upgrades can be added to the home’s tax basis, which is typically the amount that was paid to purchase the home. The basis is what is deducted from the amount realized from the sale. It’s the sales price minus any selling costs, such as real estate commissions.

People who live in a home for two of the five years prior to the sale can exclude up to $250,000 of those profits from taxes. (Married couples can exclude up to $500,000.) Unfortunately, those limits haven’t changed since 1997 even as the average home sale price has nearly tripled.

Too often, people don’t discover they owe a tax bill until after they’ve invested the money in another home or otherwise spent it. If your daughter hasn’t already, she should consult a tax pro so she understands what, if any, taxes she may owe on her sale.

Q&A: How to reduce capital gains taxes on a home sale

By

Dear Liz: We’re retired and living in California. We are planning on selling our home, which is paid for, and moving to Tennessee in a couple of years. I think we qualify for a “one time” capital gains exemption. Our home is worth over $1 million and we paid only $98,000 in 1978. We plan on buying a home in Tennessee for around $800,000. Will we have to pay capital gains tax?

Answer: Before 1997, a homeowner could defer paying taxes on home sale gains as long as they rolled the proceeds into the purchase of another home of equal or greater value. In addition, there was a one-time exclusion for homeowners over age 55, who could exclude up to $125,000 in home sale gains.

Those rules were replaced in 1997 with the current law. Now homeowners of any age can exclude up to $250,000 each in capital gains on the sale of their primary residence, as long as they’ve owned and lived in the house for at least two of the previous five years. As a married couple, you can exclude up to $500,000 of gain — but that still leaves you with more than $400,000 of potential capital gains.

The capital gains calculation doesn’t factor in the value of your replacement home or whether you have a mortgage. However, you can use the value of home improvements you’ve made over the years to reduce your taxable gain — assuming you kept those receipts. The IRS defines home improvements as expenses that add to the value of your home, prolong its useful life or adapt it to new uses. Examples would include additions (bedrooms, bathrooms, decks, garages, etc.), heating or air conditioning systems, plumbing upgrades, kitchen remodels and landscaping, among other costs.

Improvements don’t include maintenance required to keep your home in good condition, such as painting, fixing leaks or repairing broken hardware, or improvements that are later taken out. If you put wall-to-wall carpeting and then removed it to install hardwood floors, only the cost of the hardwood floors would count.

Many of the costs you incur to sell the home, such as real estate agent commissions and notary fees, also can be used to reduce the capital gain. You can find more details in IRS Publication 523, Selling Your Home. A big home sale gain can affect other areas of your finances, such as your Medicare premiums, and may require you to pay quarterly estimated taxes. Consider talking to a tax pro before the sale so you know what to expect.

Q&A: House sale implications for retiree

By

Dear Liz: I’m 67, divorced since 1992 and retired with a good government pension, a retirement investment fund, some stocks and cash savings. I plan to sell my home of 33 years soon for a hefty profit and buy a smaller home. I owe $100,000 on the mortgage. I worry about a significant increase in payments to Medicare and tax obligations to the IRS. What financial advice do you have for me? This is my first time selling and buying a property on my own.

Answer: Now would be a great time to consult a tax professional about your options. You can exempt as much as $250,000 of home sale profit, but gains beyond that would incur capital gains taxes and could increase your Medicare premiums.

The amount you owe on your mortgage doesn’t affect the tax you owe on a home sale, but other expenses might. For example, you may be able to reduce your taxable profit if you kept good records of the amounts spent on home improvements. What you spent on maintenance and repairs over the years won’t help, but any work that improved the value of your home may be added to what you paid for the home to increase your tax basis. This basis is what’s subtracted from the sale price to help determine your taxable profit. Certain expenses you incurred to buy your home, such as closing costs, and to sell it, such as real estate commissions, also can help reduce the taxable portion.

IRS Publication 523 goes into detail about how to calculate home sale profit, but an enrolled agent (you can get referrals from the National Assn. of Enrolled Agents) or a CPA could be extremely helpful in advising you about these calculations.

Q&A: House gift needs a lawyer’s help

By

Dear Liz: I have a rental house that I would like to give to my sister as an outright gift. (She is the current tenant but cannot afford to buy the house.) How can I do this legally? Do I need a lawyer? If so, what kind? I have already asked a real estate agent, and I’ve been told that I don’t really need her services. She suggested asking an escrow company. The house is in the name of my revocable trust and I own it free and clear. For various reasons, I would like to give her the house now rather than leave it to her in my will. I realize she will be stuck with my cost basis, but she has no plans to ever sell it because she has lived there for 10 years and wants to live in it for the rest of her life.

Answer: Talk to a real estate attorney, who can help you through the multi-step process of transferring a house deed and getting it recorded. You could try to do it yourself, but the attorney can ensure the transfer is done properly and answer any questions you may have.

Because the house probably is worth more than the annual gift exemption limit — which is currently $15,000 and rising to $16,000 next year — you also will have to file a gift tax return. Actual gift taxes aren’t owed until you’ve given away millions of dollars in your lifetime. If you’re wealthy enough to be concerned about that, please also consult an estate planning attorney.