Get smart with your money
By Liz Weston
Dear Liz: Just moving your holdings from one broker to another should not trigger any capital gains implications if you journal over your stocks, bonds and mutual fund holdings without liquidating anything. Right?
Answer: Right, unless you’ve been sold a proprietary investment that can’t be moved to a competitor. Some brokerages create their own funds that have to be liquidated before the money can be transferred.
By Liz Weston
Dear Liz: We are in our 70s and have owned a home in the San Francisco Bay Area for 30 years, so as you might imagine we have a sizable capital gains issue. We are starting to think about a “next step.” While I understand we would have a $500,000 exclusion and can “back out” any improvements, we would still be looking at a pretty hefty number.
We’ve had some people tell us that we would be able to take advantage of a one-time exclusion for the whole gain, but I certainly haven’t been able to find anything about this. I know if we purchase another home in California, we can keep our existing property tax basis, but in the scheme of things, that’s not a major benefit.
Any idea what these folks might be talking about?
Answer: They’re talking about an option that disappeared not long after you purchased your home. Some people are under the illusion that the old tax break still exists, because versions of this question seem to hit my inbox at least once a year.
Before Congress changed the law in 1997, homeowners could defer taxes on home sales by purchasing another house of equal or greater value. Those 55 and older could take a one-time exemption of $125,000.
That was replaced by rules allowing homeowners to exempt up to $250,000 each (or $500,000 for a married couple), limits that haven’t been updated since.
When the law was passed, few home sellers had enough capital gains to worry about exceeding the exemptions. Consider that the median home sale price in the Bay Area was just under $300,000 in 1997. Last year, the median was about $1.2 million.
A sizable capital gain doesn’t just deliver a painful tax bill. Your Medicare premiums may also temporarily increase, thanks to IRMAA, the income-related monthly adjustment amounts.
One more thing: please don’t dismiss the value of California’s Proposition 19, which allows homeowners aged 55 and over to transfer their property tax basis to a new home.
Your property tax bill is dramatically lower than what you’d pay if you were buying into your neighborhood today. That’s thanks to California’s earlier Proposition 13, which limits annual property tax increases.
A home purchased for $300,000 30 years ago probably has an annual property tax bill today of around $7,000. That same house, if purchased now for $1.2 million, would generate a tax bill of around $15,000.
Your ability to transfer your tax basis means you can save thousands of dollars annually for the rest of your life. That would be a huge benefit in most people’s scheme of things.
By Liz Weston
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.
By Liz Weston
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.
By Liz Weston
Dear Liz: I am 74 and my husband is 68. We have decided to sell our last home and rent. Do we have to pay taxes, specifically capital gains, on the sale of our last home or are we able to keep the sale proceeds in full?
Answer: Any home sale is potentially subject to capital gains taxes. Your gain is determined by subtracting your tax basis — the price you paid for the home, plus any qualifying improvements — from the net sales proceeds. If you owned and lived in the home as your primary residence for at least two of the previous five years, you can exclude up to $250,000 (or $500,000 if married filing jointly) of home sale profits. You would owe taxes on the capital gains that exceed those limits.
A large-enough capital gain could affect how much you pay for Medicare. The “income-related adjustment amount,” or IRMAA, is based on your income two years prior, so a big gain in 2025 could increase your premiums in 2027.
You’d be smart to talk to a tax pro before you sell so you understand the ramifications.
By Liz Weston
Dear Liz: You recently answered a question from a home seller who had lost documentation about improvements. The improvements most likely required building permits, which would have indicated the scope of improvements and, possibly, the cost as well. The local building department will have copies of those permits on file, and they can be obtained at a modest cost.
Answer: Thank you. The original letter writer had lost their documents in a house fire, a circumstance now shared by far too many in the Los Angeles area, thanks to the recent wildfires.
To recap, the value of qualifying home improvements can reduce the taxable gain when a house is sold. But if audited, sellers probably would need some kind of proof the work was done.
Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting, suggested asking any contractors that were hired to provide verification of the projects and to check with the property tax assessor to see if the improvements were reflected in the home’s assessment. Photos of the home reflecting the improvements could also help in an audit, Luscombe says.