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real estate

Q&A: When landlords move in to an old rental, are tax breaks part of the deal?

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Dear Liz: My husband and I bought a single-family home as a rental property in 1988. We paid $135,000. The tenants moved out in February and we are doing major upgrades now. If we moved into the property and sold it after two years, would the first $500,000 of gain be excluded from income tax? The property is under our family trust and our two daughters are successor co-trustees.

Answer: Generally speaking, a former rental property can qualify for the home sale exclusion as long as the owners claim it as their primary residence for at least two of the five years before the sale.

The home could still be subject to depreciation recapture, however, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. You probably deducted depreciation on the rental over the years — basically reflecting the wear and tear on the property. The IRS typically requires that tax break to be paid back when the property is sold. You won’t be able to exclude the part of the gain that’s equal to any depreciation deduction allowed or taken after May 6, 1997, Luscombe says.

If your trust is a revocable living trust, which is designed to avoid probate, your ability to take the home sale exclusion won’t be affected. Other types of revocable trusts may require the home to be taken out of the trust before it’s sold, Luscombe says. If it’s an irrevocable trust, the sale of the home generally would not qualify for the home sale exclusion, he says.

You should discuss this with a tax expert before proceeding, and consider reviewing other options for reducing taxes. For example, if you kept this home until death and bequeathed it to your heirs, there probably wouldn’t be any tax on the appreciation that occurred during your lifetimes.

This week’s money news

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This week’s top story: What the big relators settlement means for home buyers and sellers. In other news: The evolution of retirement and what it might mean for you, next target in Biden vs. junk fees, and dynamic pricing.

What the Big Realtors Settlement Means for Home Buyers and Sellers
The agreement could mean that home buyers would set their own agents’ pay, and sellers might save on commissions.

The Evolution of Retirement — and What It Might Mean for You
From adapting your portfolio to playing more pickleball, here’s how retirement might be shaping up for you.

Next Target in Biden vs. Junk Fees: Colleges, Student Lending
The Biden administration is now tackling fees that fall on college students and student loan borrowers.

Wendy’s Isn’t the First: Dynamic Pricing Is Everywhere
Dynamic pricing uses real-time supply and demand data to fluctuate prices up or down.

Q&A: Capital gains tax

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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

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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.

Friday’s need-to-know money news

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Today’s top story: Using credit card points at checkout has become too easy. Also in the news: Why summer jobs are good for the teenage wallet, how to maximize your music festival savings, and how long it’ll really take you to save for a down payment.

Using Credit Card Points at Checkout Has Become Too Easy
Points may be worth less when redeemed this way. And be careful — you might even cash in points accidentally.

A Summer Job: Good for the Teenage Soul and Wallet
It’s been a rough couple of years, especially for teenagers.

Maximize your music festival savings
Summer music festivals can be a once-in-a-lifetime experience, but costs can easily blow a hole in any budget.

How Long It’ll Really Take You to Save for a Down Payment
It’s probably going to take a while in this market, but let’s crunch some numbers.

Q&A: Homeownership and taxes

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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.