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Capital Gains Question


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Sandy's Forum Posts: 17

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By Sandy in Coolidge, AZ on 6/26/2005


Okay, I have a question about capital gains, and yes, I already read the other capital gains thread. Here is my question. My DH and I are going to sell our house that we have lived in for a little over 2 1/2 years, but only owned the house for the last 6 months. Anyway... we bought the house 6 months ago for $135,000 and we just put it on the market for $249,500. Our Realtor suggested that we speak with a tax person regarding capital gains, since we are not putting the profits from the sale of our current home into another home instead we are going to buy our land and use that money to buy materials for the house. 

So do I have to pay a capital gains tax on that money even though the entire amount of the proceeds are going toward another house?

I'm so confused?

Thanks.

Sandy


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By Robert in Houston, TX on 6/30/2005


Hello,

I am in a similar situation to Sandy, but with a slight variation. I have owned my lot for five years, plan to O-B my house, sell it and move all the capital gain to my next O-B investment. I will not use the house as my permanent residence and hope to sell it within the tax year (three months or less after certification for occupancy).

I have called the IRS Help Line (1-800-829-1040) and was told since the house would be built and sold in less than a year, this is a short-term investment (regardless of the fact that I owned the land for five yrs). The capital gains tax would be equivalent to my income tax percentage for the tax bracket I fall in. In other words, it would be taxed as regular income.

The other possibility is to file the property under a business using my DBA (Doing Business As) license. I am in the process of researching this.

If anyone has any comments/clarifications on my understanding of this tax rule, I'd appreciate the input. I do not completely understand my options here. I was hoping I could roll the capital gain into my second O-B home without tax liability.

Any help would be appreciated.

Thanks,

Robert


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By Peter in Gilford, NH on 7/19/2005


Sandy,

To qualify for the tax exemption, I believe you must have owned and occupied the property, as your principal residence, for an "aggregate" two of the five years before its sale.

From your post, it seems that you occupied the property for more than two years, but did not own it for two years.

The actual law in question is the 1997 Taxpayer Relief Act, Congress, in IRC Section 121. You should read the actual text of the law and make your own determination.

But not all is lost... I think with a little bit of work, you could defer your taxes using a 1031 tax exchange. This allows you to put the "profit" (or "basis" for tax pros) into your new residence without paying taxes. It's purpose is for the problem at hand. However, it's not quite as good as the tax exemption. The tax exemption forgives taxes on the first $500K and the later 1031 defers the tax (you still owe it, but later when you sell your new house). If you live in the new house for more than two years before you sell, you will be exempt for $500K of the profit from the old house and new house combined. If you think your profit between your old house and new house will be less than $500K, then the net effect would be the same. If you sell the house before the two years are up, you would have to pay the taxes based on the profits from both houses at that time (as regular income!).

Hope this helps...

Peter

BTW, I'm not an tax accountant or lawyer, just one of the strange people who sleeps with the IRS code under this pillow at night. Hence, before you decide anything, buying an hour of a "real" expert's time is worth the money. Tell them you want tax advice AND DO NOT WANT THEM TO FILE YOUR RETURN REGARDING THIS MATTER! That's another post to explain why...


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James's Forum Posts: 72

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By James in Broadview Heights, OH on 7/19/2005


From what I have read, you can file a grievance if you have to move due to a job relocation or other issues. I would definitely consult with an accountant or tax attorney. Good luck!
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Netie's Forum Posts: 84
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By Netie in Salt Lake City, UT on 7/20/2005


*To qualify, you must have lived there - a total of two years - within a maximum five-year period - as a primary residence.    

*IRS easily accepts: single-family residences, boats/yachts, townhomes, condo's and co-op's... 

*But you can file for acceptance of a 2-4 family residence w/a percentage adjustment if you depreciated, mobile homes (if on perm. foundation), and land if you can show habitual improvements (for the serious hermit-back-to-the-landers only).

*Not happening: Motorhomes, small apt. in a garage/shop (actual % needed), any apt. of five or more units, commercial condo/retail/storage space...

If you built a tree house in Hawaii - yes it can be done - but you've got to prove it, and proof can sometimes depend on how good a day the IRS agent is having.

Just my basic knowledge gathered from reading and talking to folks.

Oh hark, doth this issue raise its ugly head, and escape not us Americans ever? Sad are our founders.

- Netie


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Baine's Forum Posts: 66

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By Baine on 7/21/2005


1. Capital gains for an A. Primary residence, and B. Investment property (which is ANYTHING OTHER THAN a primary residence) MUST ALWAYS be separated according to tax code. ACCEPT THIS, PEOPLE!!

This means that if you have cap gains from an investment property, it CANNOT UNDER ANY CIRCUMSTANCE be rolled or 1031'd into a primary residence. PERIOD.

This also means that you CANNOT UNDER ANY CIRCUMSTANCE roll or 1031 your gains from a primary residence you have lived in for less than two of the last five years into ANY other property OTHER THAN your new PRIMARY residence where you live.

The only thing I am not sure on, is if you can roll CG from your primary you have lived in for less than two years of the last five into a new primary. I am 99% sure that you cannot, but not 100%. I do not think you can; it does not make sense tax-code wise to be able to, but there might be something there and I will look into this and re-post.

Baine


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Baine's Forum Posts: 66

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By Baine on 7/21/2005


Here is a legal interpretation of the tax code.

The current law, found in §121 of the tax code, eliminates many of the complications and restrictions involved with selling a home tax-free. A single taxpayer wishing to sell a home may now exclude up to $250,000, and married couples filing joint federal returns may exclude up to $500,000, so long as certain ownership and use requirements are met. The age restrictions have been eliminated, and a taxpayer may take advantage of the exclusion on the sale of one principle residence every two years. In order to qualify under §121, a taxpayer must have both owned the property and used the home as a principal residence for at least two out of the last five years ending on the date of sale. The IRS uses a facts and circumstances test to make ownership and use determinations. Some factors the Service may look at include: place of employment, the address listed on bills, driver's licenses and tax returns, and locations of churches, clubs and organizations attended by the taxpayer.

The two-year requirement need not be consecutive, so long as a full 24 months or 730 days can be aggregated. Where a taxpayer owns more than one home, using each as a residence, the property in which he or she spends the most time will normally be considered the "primary residence."

Special rules may apply to exclude gain under §121 when the use and ownership requirements cannot be met. For example, if a person becomes physically or mentally incapable of self-care and must be moved to a care facility, the two-year-use requirement is reduced to one year. If a taxpayer is forced to sell a home due to a change in employment, health or other unforeseen circumstances, a portion of any gain may be excluded, even though the property had not been owned or used for two years.

== it is clear that you cannot roll CG from a house you have lived in as a primary residence for less than two years into the new primary. This is only available for investment property through a 1031 exchange.

Baine


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Baine's Forum Posts: 66

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By Baine on 7/21/2005


You're only entitled to cash in on tax-free capital gain on the sale of your primary residence. If you own income-producing property, you must pay tax on the gain when you sell unless you complete a 1031 tax-deferred exchange. A 1031 exchange allows you to roll gain from one income-producing property into another income-producing property. You ultimately have to pay tax on the gain, but a 1031 exchange permits you to defer capital gain tax payment in the future.

Home Seller Tip: Some homeowners are incorporating current tax law into their retirement planning. Recently, an Oakland, Calif., couple sold an apartment building using a 1031 exchange. With the proceeds, they purchased, or traded into, a home they'll ultimately occupy when they retire. Until they retire, the property will be rented. So, they traded one rental property for another and deferred paying tax on the gain.

At retirement, they will sell their current residence and collect $500,000 of tax-free gain. Then they'll move into the rental property they acquired in exchange for the apartment building they sold years before. For tax purposes, they'll convert the rental property to their primary residence and will avoid paying tax on the gain of the investment properties.

More good stuff!

Baine


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