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capital gains on a home sale

Q&A: Time to move, but what about the capital gains?

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Dear Liz: My husband and I built a home on a hillside over 30 years ago in a desirable neighborhood with a beautiful view. We thought it would be our retirement home, but life had different plans. Now seniors, dealing with age, stairs and progressive health issues, we have been advised that selling and moving to a senior assisted living facility is the best option for us before we are forced by circumstances to move. And, we were told, it would be less expensive than having full-time, in-home care.

We are concerned that capital gains would take a big chunk out of the sales proceeds from our home, and that’s money we need to pay for assisted living. Can we use the purchase price of the vacant lot against the capital gains? Can we use the bank loan for building the house against the capital gains? Can we use the cost of an apartment or condo in an assisted living residence against the capital gains? What other things can be used against capital gains other than general home improvements?

Answer: A large gain wouldn’t just reduce the amount of money you have for the next phase of your life. It also could increase your Medicare premiums for a year, thanks to the income-related adjustment amount or IRMAA.

You’ll determine your potentially taxable capital gains by deducting your tax basis from your home sales proceeds. Your basis includes the purchase price of the lot and the cost of construction, plus any qualifying home improvements you’ve made over the years.

The two of you can shelter up to $500,000 of home sales profits from capital gains taxes. Capital gains also can be reduced if you have capital losses — in other words, if you’ve sold stocks or other assets for a loss.

What you do with money doesn’t affect the capital gains taxes you pay. Decades ago, you could defer capital gains by buying another home of equal or greater value, but that’s no longer the case.

You may have some alternatives to lessen the impact of the gains, such as an installment sale where the buyer pays over time. Another option would be renting out rather than selling your home.

A tax pro can provide guidance.

Q&A: Counting freeloading relatives as a hardship? Not so fast, the IRS says

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Dear Liz: I lived in a house for 45 years. During that time, my daughter and her family moved in due to the 2008 financial crisis. I have not charged her rent. However, I moved out five years ago, and her family is still there rent-free. I understand that when I sell, I will owe capital gains tax because it is no longer my primary residence. Are there any hardship rules that may help me?

Answer: Unfortunately, the IRS doesn’t consider freeloading relatives as one of the hardships that can modify the home sales exclusion rules.

Your capital gain will be calculated by subtracting your tax basis in the home from the sales proceeds, minus selling costs. Your tax basis is generally what you paid for the house, plus the cost of qualifying upgrades.

You can exclude up to $250,000 of home sale capital gains (or $500,000 if married filing jointly), but only if you’ve owned and lived in the property as your primary residence for at least two of the past five years. There is a partial exclusion for people who fall short of the two-year mark because of certain reasons, such as a work- or health-related move.

Q&A: Losing a home in a fire, then being hit with a ‘casualty gain’

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Dear Liz: My house was burned down in the Palisades fire. I lived in the house for 25 years and lost everything. I thought there may be a silver lining with tax deductions. Much to my surprise, I am supposed to use the purchase price from 25 years ago as my adjusted cost basis. The insurance settlement is not going to be enough to rebuild but is more than my cost basis. I will end up with “casualty gain” instead. Is this possible?

Answer: After losing your home and finding out you were underinsured, the news that you might have a taxable gain must have been a gut punch.

The IRS calls it an “involuntary conversion” when your property is destroyed and you receive insurance proceeds. If the insurance payment exceeds your tax basis in the property, that’s known as a casualty gain.

You can defer tax on this gain if you use the insurance payout to rebuild or buy a replacement property, says Mark Luscombe, a principal analyst with Wolters Kluwer Tax & Accounting. Normally you’d have two years to use the insurance proceeds, but in a federally declared disaster such as the Los Angeles fires, the deadline is extended to four years.

The IRS may be willing to further extend the deadline under some circumstances, such as contractor delays, Luscombe says. But don’t count on an extension if you’re simply unable to find a replacement property.

If you do purchase a new home elsewhere, any gain from the sale of the lot where your previous home stood also would have to be reinvested in the new home to avoid a current tax on the gain, Luscombe says.

However, the home sale tax exclusion also applies to involuntary conversions. The exclusion allows you to shelter up to $250,000 of gains ($500,000 if married filing jointly) on a sale or involuntary conversion, as long as you’ve owned and lived in the property as your primary residence for two of the last five years. So you could exclude that amount of gain and defer the rest if you rebuild or find a replacement property, Luscombe says.

This is complicated territory, so please make sure you hire a tax pro to guide you.