Combine Two Top Homeowner Tax Breaks
Suppose you are selling your home at a sizeable gain. Although you can
benefit from the giant home-sale exclusion, part of the profit will still be
subject to tax.
Intriguing idea: Fortunately, there is a way you can combine the home sale
with a like-kind exchange. In other words, you could convert the home to a
rental property before you sell it. As long as you meet all the tax law
requirements, you qualify for this tax-saving parlay.
The IRS recently approved the technique in Revenue Procedure 2005-14. Let’s
quickly review the two tax breaks:
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If you have owned and used your home as your principal residence for at least two of the last five years, you can choose to exclude up to $250,000 of gain from tax. The exclusion is doubled to $500,000 for joint filers. This tax break can be used an unlimited number of times.
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If you own business or investment property, you can arrange to exchange it tax-free for other “like-kind” property. Any “boot” received in the deal, such as cash or assumption of a mortgage, is currently taxable. But the boot is taken into account only to the extent it exceeds any gain under the home-sale exclusion.
Of course, your basis in the new rental property must be adjusted to reflect
the exchange. Your adjusted basis is equal to the relinquished property plus
the exclusion amount. In effect, the amount excluded under the home-sale tax
break is treated as gain on the exchange. This effectively increases the
basis of the new property.
Example: John bought his primary residence years ago for $210,000. He starts
renting the home this year. After claiming depreciation deductions of
$20,000, in two years John swaps the home for a condo he plans to rent and
$10,000 in cash. The fair-market value of the condo is $460,000 when the
properties are exchanged.
The adjusted basis in the old home is $190,000 ($210,000 cost minus $20,000
depreciation), so John realizes a gain of $280,000 ($460,000 value plus
$10,000 cash less $190,000 basis).
Tax payoff: Under the 2005 ruling, John first collects the $250,000
exclusion amount tax-free. Then he defers the remaining gain of $30,000
(including the $20,000 attributable to depreciation) as a like-kind
exchange. Although he is receiving $10,000 in boot, John does not have to
pay any current tax because it does not exceed the amount of the excluded
gain. Finally, John’s adjusted basis in the condo is $430,000 ($190,000 plus
$250,000 excluded gain minus $10,000 cash received).
To ensure that your transactions comply with all the tax rules, obtain
guidance from a
Somerset professional tax advisor.
Wherewithal
is provided by Somerset for our clients and other interested persons
upon request. Since technical information is presented in generalized
fashion, no final conclusion on these topics should be made without
further review. For additional information on the issues, please
contact
a member of the firm. Somerset provides total financial solutions,
including accounting, assurance, information solutions, litigation &
valuation, tax, wealth management and management consulting services to
entrepreneurs and their businesses. This document is not intended or
written to be used, and cannot be used, for the purpose of avoiding tax
penalties that may be imposed on the taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
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