IRS taking a bite out of Real Estate exchanges
August 25th, 2008 Categories: Market Conditions, Real Estate Tales, Selling Thoughts
Ever feel like yo
u can’t win for losing? Beware, the IRS is closing loopholes on Capital Gains for 1031 real estate exchanges. Here we go again - the IRS is changing the status of what constitutes capital gains on investment property. As if we don’t already have enough to think about as a real estate investor. The reason I bring this up is because we are in a super “investor” real estate market right now. I live and work in Boulder Colorado where we have people moving here from all over the world, not only because of the beautiful scenery, but because it’s still a good place to invest and that appreciation of the homes are still above average. I recently picked up a buyer that was looking at one of my foreclosure listings and she was thinking about buying it as an investment and then moving into it themselves in the next few years.
Currently the capital gains IRS laws for real estate say that if you personally live in the investment property for a minimum of 2 years prior to selling the home, the IRS basically de-classifies it as and investment property and allows you to sell it as your primary residence and exclude up to $250,000 in gain ($500,000 if you are married) and not have to pay capital gains tax on that portion of the gain of your sale. If your gain is more than your exclusion than of course that portion after the exclusion could be deferred and carried to the next residence. I’m talking ” Investment 101 for Dummies” here guys…so if you’re not sure what “gain” is, it’s basically the amount you paid for the property, plus any capital improvements (not cosmetic) done over the years that you owned it, subtracted from your sale price (less any costs that you had to do to get it ready for the sale). Currently the tax rate for most taxpayers is 15% on long-term capital gains (property that is held for longer than 12 months) and ranging from 10%- 35% on short term capital gains (property held for less than 12 months). Right now, individuals in the 10% and 15% tax brackets (that’s the tax level you are at when you figure your total taxable income for your tax return) pay 0% on long-term capital gains.
The new IRS rule which goes into effect starts Jan 1, 2009 states that you cannot take the full tax exclusion ($250,000 or $500,000) on the sale of your home if it was your investment property before it was your primary home. The IRS wants you to separate the “qualified time” (the period of time that it was used as your personal residence) and the “non qualified” time (the time it was used as a rental). Basically you will have a reduced “tax free exclusion”. Non qualified time prior to Jan, 1, 2009 is not taken into account in allocation for non qualified use but is taken into account for ownership (that is a question for your tax adviser) .
Say you bought a house in 2002 and rented it out for 4 years and then moved into it for the last 2 years as your personal residence: Here is what will happen if you sell it after Jan 1, 2009.
Current After Jan 1, 2009
Gain on sale: $250,000 $250,000
Exclusion: - $250,000 - $ 50,000
Capital Gain: $ 0 $ 200,000
15% tax $ 0 $ 30,000
Basically the 4 years that you owned it as a rental doesn’t qualify for the exclusion.
When you report your taxes for that year you sold the house, you have to add back into your income the capital gains (and of course the IRS will have a form that calculates all the non vs qualifed time etc…) and at what rate you will be taxed, depending on all of your other taxable income. If you were taxed at a 15% rate that could mean a difference of $30,000.
Not small pocket change. Of course, the whole concept of 1031 exchanges allows you to roll capital gain into the next investment property (and not pay tax on it the year you sell it and roll it into another property), which is a great idea, it might just cost you more in the long run when you eventually sell it outright. By the way, they call this the Housing Assistance Tax Act of 2008…..let me know if you see where the IRS is making an assist! Maybe by the time you sell down the road the IRS will change the rules again. Please note that it is imperative that you check with your tax and investor advisers on this as I am not a tax adviser, just a interested Realtor trying to pass along some good info.
hey converted an investment or rental property into their primary residence they can no longer take the full tax exclusion, on the sale of their primary residence, provided under Section 121.
Prior to this act, taxpayers could under Section 121 defer capital gains tax on the sale of their primary residence regardless of how the property was used before it’s conversion to a primary residence. Section 121 allows a person to exclude up to $250,000 in gain or $500,000 for a married couple or domestic partners.
