Tax breaks for home sellers

If you sold your personal residence during 1995, Uncle Sam is expecting a report and possibly additional tax dollars from you. Here are some tax tips that will help you maximize the benefits of homeownership and minimize your tax bill.

First, the IRS wants to know if you sold your home, regardless of whether you lost or made money on the sale. If you lost money, you have a personal loss that must be reported, although it may not be deducted. If you made money, you have a taxable capital gain; however, you may be able to limit or postpone the tax.

General deductions

To limit your tax, deduct your allowable home mortgage interest and property taxes paid up to, but not including, the date of the sale. These deductions can be substantial, so review them carefully. "A homeowner could save hundreds of dollars each month," says Steve David, a real estate tax instructor and president of Century 21 TriCity Realty Inc.

For example, David explains, homeowners who have mortgaged $100,000 may pay roughly $6,000 in mortgage interest and $3,000 in property taxes (depending on where the home is located) each year. Assuming that these fees qualify as deductible expenses, homeowners in the 28 percent tax bracket could save $2,520 each year, or $200 a month, in income taxes.

If you incurred a penalty for paying off your mortgage early, you are allowed to deduct the amount paid because the IRS views this penalty as interest. If you have any points that have not been deducted (such as those being deducted proportionally over the life of the loan), you may deduct the balance in the year of the sale.

When deducting expenses, keep in mind that each item may be deducted only once.

How to calculate your gain or loss

Next, calculate your gain or loss from the sale by answering the following questions:
What was the selling price? This is simply the amount of consideration (money plus the fair market value of other property received) the buyer gave you for your home.
How much did I realize? The amount you realized is the sales price of your home minus your selling expenses. Selling expenses are costs and fees you (not the buyer) paid in order to sell your home. Some examples include: commissions, escrow fees, legal fees, transfer taxes, points for the buyer's loan, advertising costs and fix-up expenses (include fix-up expenses in this calculation only if you plan to purchase another home within two years).

Fix-up expenses include costs for decorating and repairing your home in order to make it more sellable. The work must have been completed within 90 days before the contract was signed, and you must have paid for it within 30 days after the sale. Some examples include: painting (materials and fee for hiring a professional) and exterior flowers. This does not include everyday expenses, such as fees for cleaning services.

What was the adjusted tax basis? The original tax basis of your home is the amount you paid for it, plus any acquisition costs that were not deducted in the year of purchase. Your basis may be increased or decreased by certain expenditures, at which point it's called the adjusted tax basis. Generally, the higher your basis, the less likely you'll have to pay taxes on a gain.

To determine your adjusted tax basis, start with the amount of money you paid for your home (down payment and borrowed amount) and add the amount you paid for the following items (if applicable):

Capital improvements, which are permanent items that increase the property's value beyond the taxable year in which they were installed. The cost of a swimming pool or remodeled kitchen applies here.

This category also includes the cost of items that restore damaged property, minus insurance proceeds, such as a new roof after a storm.

A word of caution: There are many gray areas in this category. For instance, if you purchase a spa and place it on your patio, it is not considered a capital improvement. However, if the same spa is built-in to your deck, it is considered a capital improvement. When in doubt, consult a tax professional.
Settlement fees and closing costs that are charged in connection with the purchase of a home. Some examples include: attorney's fees, surveys costs, transfer taxes and owner's title insurance premiums. Expenses that are charged in connection with obtaining a mortgage, such as points and loan origination fees (if charged as prepaid interest, not as payment for services), may not be added to your basis. However, these expenses may be deductible.
Assessments for local benefit, such as charges for the construction of a sidewalk or street lights.
Real estate taxes that cover time after you sold the home, for which you were not reimbursed by the buyer.

From that number, subtract the following amounts (if applicable):
Any expense for which you were liable but that was paid by the buyer. These only apply if you did not reimburse the buyer. Expenses such as property taxes and points may fall into this category.
Any postponed gain from a former residence.

How to postpone the gain

If you have a gain, you may postpone paying tax on it if you use the money to buy a more expensive home within two years before or after the sale.

If you're building a new home, you must purchase and occupy the home within two years before or after the sale; however, construction may start before and continue after the four-year period. Members of the U.S. armed forces serving on extended active duty and people who maintain a home outside the United States after the sale of their U.S. residence may take advantage of slightly different timing rules.

If you use the proceeds of your sale to pay for a unit in a retirement home but you do not have any legal interest in the property, you have not met the requirements of this exemption. However, if you are at least 55 years of age, you may consider using the one-time exclusion (discussed later).

If you change your mind about using the postponed gain exemption after you've filed your tax return, you may change your election by filing an amended return. Generally, you have three years from the time the return was filed or two years from the time the tax was paid, whichever is later, to file an amended return.

Special exemption for those 55 and over

If you are at least 55 years of age on the day your sale closes, you may be able to avoid paying taxes on up to $125,000 of the gain on your sale. You may take advantage of this exemption, known as the one-time exclusion, if both of the following conditions are true:

You owned and used the property as your principal residence for three of the five years preceding the sale.
Neither you nor your spouse has ever taken the exemption. If you are under 55 on the day you sign the contract, you may still use this exemption as long as you are at least 55 on the day the transaction closes.
When a property is owned by a husband and wife, you both are treated as meeting the requirements if the following conditions are true:
You and your spouse own your property as joint tenants, tenants by the entirety or community property.
You and your spouse file a joint tax return for the year of the sale.
Either you or your spouse meets the age, ownership and usage requirements.
After you have filed your tax return for 1995, you may make or revoke your election to use this exemption any time within three years from the time the original return was filed or two years from the time you paid the tax on the sale, whichever is later.

For More Information

To find out more about these deductions or other tax breaks for homeowners, contact a tax professional, call the IRS at 800/829-1040 or review the following IRS publications: Selling Your Home (Pub. 523), Moving Expenses (Pub. 521), Home Mortgage Interest Deduction (Pub. 936) and Tax Information for First-Time Homeowners (Pub. 530). You can find most of these publications in your local library.

On the Internet, you can find more information on the IRS home page (www.fedworld.gov).