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Minimizing the Capital-Gains Tax on Home Sale

The big concern for long-time homeowners today is having to pay capital-gains tax on the net profit that’s ABOVE the exempted $500,000 for married couples.  While the 2-out-of-5-year rule that was passed in 1997 is due for some adjusting, there haven’t been any indications that the politicians will re-visit the issue.

What can homeowners do to minimize the tax owed?

  1. Document Your Expenses. All home improvements (not repairs) and closing costs are added to your home’s cost basis (purchase price), which help to minimize the taxable gain.
  2. Carry the Financing. Have a big equity position and don’t need all the money? Take payments from the buyer over time, instead of receiving all the cash at closing. Require a big down payment so you would receive a nice chunk up front, and then collect on a 5% mortgage over the next 5-10 years. You only pay tax on the money received, so structure it so you drop down into the 15% tax bracket for the first year:
  3. Rent it out for a year and do a 1031 Exchange. After renting your home out for a year, you could trade it for another rental property and postpone the capital-gains tax indefinitely. You have to rent out the new home too for at least a year before occupying as your residence, so it is a 2+ year project – but hey, no tax! If you don’t need to live there, another alternative is to buy a property in an ‘opportunity zone’. Investors begin to enjoy a step up in basis after 5 years. After 10 years, the gains become tax-free!
  4. Offset with capital losses from elsewhere. Business and stock losses can be included in the same tax return to offset the capital gains.
  5. Move every time your net gain rises up to $500,000. You may have to take a hit this time, but to avoid having to pay capital-gains tax again in the future, move more often. 🙂
  6. Dying correctly. The burden of being the remaining spouse after a full life together can be devastating, but at least he/she will have the cost basis increased to the home’s value on the day of death – with no capital-gains tax owed. Make sure to have your family trust named as owner of the home.
  7. Wait until your home’s value goes down.  This isn’t likely to happen, so focus on 1-6 above!

Virtually every long-time homeowner has seen their equity rise enough in the last 12 months to cover their tax exposure, and didn’t that feel like free money?  Instead of fretting over having to pay the government, just enjoy the ample amount left over – you made more than they did! Or utilize the tips above.

Check with your tax preparer for more details.

Prop 19 Requests Delayed

I spoke with Jordan at the San Diego County Tax Assessor’s office about their Prop 19 processing. He said they have received about 1,000 requests since Prop 19 went into effect last April 1st, and have completed about half of them. He said there is a backlog of 6-9 months because they are appraising/analyzing every property in question to ensure compliance.

There were 36,936 sales of attached and detached homes in San Diego County since April 1, 2021, so the 1,000 requests (3%) gives us a feel for how effective Prop 19 has been in getting seniors to move (not very).

From Liam at the LAT:

Rose Liebermann opened her property tax bill and did a double take.

The $15,584 she owes on her new West Hills home was almost four times as much as the taxes on her previous house in Granada Hills where she had lived for more than 30 years.

“This bill, when I saw it, I said, ‘This can’t be real,’ ” said Liebermann, 71, a clinical social worker.

It wasn’t supposed to be that way. Proposition 19, narrowly approved by California voters in 2020, gives older homeowners a property tax break when they move. Specifically, it allows those 55 and older to blend the taxable value of their previous home with the value of a new, more expensive home they purchase, resulting in significant tax savings.

But processing delays at the Los Angeles County assessor’s office have left property owners like Liebermann facing hefty tax bills that must be paid while they wait for their applications to be approved.

Nearly a year after the law took effect, the assessor’s office has not completed any of the 1,271 applications it has received to recalculate the property taxes for older and disabled homeowners under the law, according to the agency. And it hasn’t finished any of the nearly 3,700 applications for parent-to-child and grandparent-to-grandchild inheritances, the other major piece of the tax measure.

Liebermann moved last summer because she wanted to help her daughter, Natasha Gershon, who is divorced and raising two young children, including a 10-year-old son with autism. Believing the tax measure would make it possible for her to afford a nicer place, Liebermann decided to buy the larger single-family home in West Hills where they all could live.

Liebermann has since borrowed money through a refinance loan to help pay the property tax and to build an accessory dwelling unit for herself.

(more…)

Cost Basis & Capital Gains

When calculating how much your home has increased in value, you have to identify its COST BASIS – meaning anything and everything that you spent to pay for the product. The IRS defines a capital improvement as a home improvement that adds market value to the home, prolongs its useful life or adapts it to new uses. Minor repairs and maintenance jobs like changing door locks, repairing a leak or fixing a broken window do not qualify as capital improvements.

Capital improvements and things you can put in your COST BASIS include:

  • The price you paid for the property, including settlement costs, such as: title fees, legal fees, recording fees, survey fees, and any transfer taxes or fees you paid in connection with the purchase.
  • Additions: An added extra bedroom or bathroom, a deck on the back of the home, a new garage, an added porch or patio….anything that adds value to your home.
  • Lawn and grounds improvements: Value-adding landscaping projects, driveway or walkway construction, a new fence or retaining wall, adding a swimming pool, etc can qualify as property improvements.
  • Exterior improvements: New windows, a new roof, and new siding are examples. Any and all renovation costs including ANY and ALL costs related to that renovation work.
  • Insulation: This includes insulation in the attic, inside walls, under floors, or around pipes and ductwork.
  • Systems: Installing a new heating or air conditioning system, new ductwork, adding a central vacuuming system, wiring improvements, installing a security system, solar, geothermal, generators, batteries, and putting in lawn irrigation are improvements.
  • Plumbing: Installing a septic system, water heater, or soft water system adds value.
  • Interior improvements: New appliances, kitchen renovations, new flooring/carpeting, the installation of a fireplace, etc.

If you needed to make home improvements in order to sell your home, you can deduct those expenses as selling costs as long as they were made within 90 days of the closing. Your COST BASIS does NOT include hazard insurance premiums, moving expenses, or any mortgage-related charges (mortgage insurance, credit report fees, and appraisal costs are out) and general repairs that are essential to keep something working do not qualify. Yard maintenance, HOA fees, and real estate taxes don’t count. Always check with your accountant.

Keeping tabs of these costs throughout the lifetime of a house is wise.

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How do you calculate the capital-gains tax when selling?

Subtract your COST BASIS, commissions, and closing costs from your sales price to determine the taxable gain. Those who lived in the home for two out of the last five years can also subtract the $250,000 exemption if single (or $500,000 if two people), and then the rest is the taxable amount. Long-term capital gains — that is, gains on assets held for a at least a year – are generally taxed at a lower rate than earned income (money that you get from working).

In 2022, the IRS ranges are as follows:

  • 0 Percent – $0-$41,675 Single/$0-$83,350 Married
  • 15 Percent – $41,676-$459,750 Single/$83,351-$517,200 Married
  • 20 percent – $459,751+ Single/$517,201 Married

The State of California will take their chunk too. Check with your tax adviser!

Spouse Test For 2-Out-Of-5-Year Tax Exemption

How do you get the $500,000 tax exemption on the net profit from the sale of your home?

If you and your spouse file tax returns jointly, and if both meet the “use test.”  That means you both lived in the house as your primary residence for at least two of the five years leading up to the date of sale (and at least one of you are on title).  Here is the IRS rule:

 You can exclude being taxed on $500,000 of the capital-gains from the sale of your primary residence if all of the following are true:

1. You are married and file a joint return for the year.

2. Either you or your spouse meets the ownership test.

3. Both you and your spouse meet the use test during the 2-year period ending on the date of the sale.

4. During the 2-year period ending on the date of sale, neither you nor your spouse excluded gain from the sale of another home.

https://www.irs.gov/pub/irs-pdf/p523.pdf

Should a spouse pass away, the surviving spouse has two years from the date of death to sell the home and receive the full $500,000 exemption from capital-gains tax – as long as they haven’t remarried.

When to Sell Mom’s House

If you wanted proof that the tight-inventory era will persist – and possibly get worse – over the next few years…..well, here you go.  As prices have risen sharply, so has home equity – which means the long-time owners can be looking at a six-figure tax hit, even after the 2-out-of-5-year tax exemption.

While you can make the case that the capital-gains tax gets paid with the same-and-seemingly free money created by the recent home-price appreciation, Americans have a real aversion to paying taxes. Especially in six-figure amounts!

The long-timers who might consider selling their home are smart to calculate the potential capital-gains tax first.  For most, it will probably be the last straw!

Prop 19 – It’s Time!

I’ve seen two new listings mention that their close of escrow must be after April 1st!

We are within range now, so hopefully we’ll see more Prop 19 sellers putting their home on the market in the coming weeks and months. The California Association of Realtors still says that this will benefit ‘millions of seniors’ and will open up ‘tens of thousands’ of new homebuying opportunities:

  • Removes location and price restrictions on property tax transfers for homeowners who are 55+, severely disabled, or victims of wildfire or natural disaster and allows them to transfer the property tax base of their existing home to a new home anywhere in California, regardless of price (with an adjustment upward to their tax basis if the replacement property is of greater value).
  • Creates housing opportunities to build more senior housing and retirement communities for millions of seniors and Baby Boomers to retire with Prop 19’s tax benefits.
  • Generates homebuying opportunities for tens of thousands of renters, young families, and first-time homeowners.
  • Provides new revenues annually for fire protection, emergency response, local government, and school districts.

For those who like to move, you can transfer your old tax basis up to three times (though there is conflicting commentary on whether disaster and contamination victims would get three chances or continue to be allowed just one transfer).

Other nuances:

If you buy a more-expensive home, the difference between the sales prices is added to the tax basis. Example: If you sell for $800,000 and buy at $900,000, the extra $100,000 is added to the old tax basis.

You can buy the new home first, and then sell the old one.

If the sale or purchase of a primary residence takes place before April 1, 2021, and the subsequent sale or purchase takes place within two years and on or after April 1, 2021, then you may qualify. The Association is seeking clarification – check with your attorney.

The ballot measure eliminated the parent-to-child and grandparent-to-grandchild exemption in cases where the child or grandchild does not use the inherited property as their principal residence, such as using a property as a rental house or a second home. When the inherited property is used as the recipient’s principal residence but is sold for $1 million more than the property’s taxable value, an upward adjustment in assessed value would occur.

The C.A.R. is working with the state to create a streamlined process to easily transfer the old tax basis.  There are rumblings about additional legislation being needed to clarify other points – stay tuned!

https://www.boe.ca.gov/prop19/#FAQs

The San Diego County Taxpayer Advocate is available for questions:

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Prop 19 Passes

The key components of Prop 19:

Now, older homeowners (55+) can take their old property-tax basis with them when they buy a more expensive home anywhere in the state — up to three times. Homeowners with disabilities will be able to do the same, plus victims of wildfires and other natural disasters and hazardous waste contamination will be able to do so after their home is damaged.

The number of times that a tax assessment can be transferred increased from one to three for persons over 55 years old or with severe disabilities (disaster and contamination victims would continue to be allowed one transfer).

If they pay equal or less in price, the property-tax basis from their previous home transfers.

If they buy up in price, the difference between sales price of old home and purchase price of new home is added to the tax basis (pay full tax on the difference).

New residence must be purchased within two years of the sale of the previous residence.

The measure goes into effect on April 1, 2021.

In California, parents or grandparents could transfer primary residential properties to their children (or grandchildren if all parents are deceased) without the property’s tax assessment resetting to market value. Other types of properties, such as vacation homes and business properties, could also be transferred from parent to child or grandparent to grandchild with the first $1 million exempt from re-assessment when transferred. The ballot measure eliminates the parent-to-child and grandparent-to-grandchild exemption in cases where the child or grandchild does not use the inherited property as their principal residence, such as using a property as a rental house or a second home. When the inherited property is used as the recipient’s principal residence but is sold for $1 million more than the property’s taxable value, an upward adjustment in assessed value would occur. The ballot measure also applied these rules to certain farms. Beginning on February 16, 2023, the $1 million amount would be adjusted each year at a rate equal to the change in the California House Price Index.

https://elections.cdn.sos.ca.gov/ballot-measures/pdf/aca11.pdf

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Real estate interests raised more than $39 million to support Proposition 19’s passage. Realtors are expected to benefit from increased home sales, both by older homeowners deciding to take advantage of their new tax benefits to move and heirs preferring to sell their parents’ properties rather than pay higher property taxes.

Much of the Realtor-backed campaign for Proposition 19 focused on benefits to wildfire victims and increased funding for wildfire response. But disaster-affected homeowners constitute well under 1% of those eligible for tax relief under Proposition 19, according to an analysis by the California Budget and Policy Center, which found the benefits mostly accruing to older white homeowners.

And while the measure does reserve new tax revenue for wildfire response, the state’s nonpartisan Legislative Analyst’s Office believes that the vast majority of the wildfire funding will not start flowing until 2025 at the earliest.

Proposition 19 and Market Surge

Proposition 19 is on the ballot, and the California Association of Realtors wants you to believe that if it passes, there will be a surge of new inventory from seniors finally being able to sell their homes and take their ultra-low property-tax basis with them to a new home in a county not previously available.

They have deftly orchestrated a campaign that touches on all the hot buttons too. Just look at the title – who doesn’t want to protect the homes of seniors, severely-disabled, families, and victims of wildfire or natural disasters?

But they ignore that seniors have been able to sell and take their ultra-low property-tax basis with them for years – but only if they move to one of the 10 counties in California (out of 58) who have previously approved the benefit.

The ten counties are the major population centers; Alameda, Los Angeles, Orange, Riverside, San Bernardino, San Diego, San Mateo, Santa Clara, Tuolumne, and Ventura. So they want us to believe that seniors have always wanted to move to the sticks – and if passed, the taking of their property-tax basis is the game-changer that gets them to finally move?

Other thoughts:

  • How much do seniors need to spend on a replacement home in the sticks? Half a million should do it, so without Prop 19, the regular tax basis would be around $5,000 per year.  If a senior pays less than $2,000 annually on their old home….the actual savings isn’t a large amount ($1,000 to $3,000 annually) but yes, every little bit helps.
  • Did the grandkids already move to the same town? Probably a more-important ingredient than saving $1,000 to $3,000 per year.
  • It only benefits seniors leaving the big cities for small towns. Are they going to live without their modern conveniences like doctors (a big issue), shopping, entertainment, and a way of life to which they’ve become accustomed to for decades, just to save $1,000 to $3,000 per year?
  • Prop 19 protects the ability of kids and grandkids to inherit the ultra-low tax basis from the parents and grandparents.  How does that create more homes on the market?

But the Association is throwing their full weight behind Prop 19, have gotten the firefighters on board in order to play the wildfire card, and they are advertising on TV:

To me, the thought of Prop 19 creating “tens of thousands of housing opportunities” is preposterous.  But seniors are overdue, and maybe it will be the final reason that gets them to move.  For that reason, let’s add the passing of Prop 19 to our list of reasons why the 2021 selling season will be like no other!

Check out their impressive website:

https://www.carhomecoalition.com/

Prop 19 Breakdown

It was called ACA-11 while the legislators considered it, and the realtor-backed initiative is now Prop 19.  In our last installment, the legislative analysis included this gem:

Right now, around 80,000 homeowners who are over 55 move to different houses each year without receiving a property tax break. The measure would cause more people to sell their homes and buy different homes because it gives them a tax break to do so. The number of movers could increase by a few tens of thousands.

In the graph above, we see that there were 437,000 homes sales in California last year.  The analyst who prepares these studies is saying that 18% of all home sales are seniors buying up, or moving to a county that doesn’t allow for tax-basis transfers?  And if this measure passes, even more seniors will move just because of the tax break?

The analysis also includes this tax increase, but doesn’t mention the exclusion for those heirs who occupy the inherited home as their primary residence:

Under current law, between 60,000 and 80,000 inherited properties statewide are excluded from reassessment each year. Under the measure, these properties would instead be reassessed resulting in higher property tax payments. This, in turn, would increase property tax revenues for local governments.

Though the official state analysis seems far-fetched, just the appearance of being an assault on Prop 13 should be its undoing.

Hat tip to SM for sending this in from the Howard Jarvis Taxpayers Association that declares it to be just another political play to generate billions more in property-tax dollars:

https://www.hjta.org/california-commentary/proposition-19-is-latest-assault-on-taxpayers/

The California Association of Realtors has pulled in the firefighters by adding that the excess tax revenues go towards fighting wildfires.  Will that be enough smoke & mirrors (pardon the pun) to persuade voters to change Prop 13? The last attempt to pass a similar initiative in 2018 never gained traction, and it’s doubtful that C.A.R. will spend enough advertising dollars to change voters’ minds this time.

Prop 19 Explained

We heard from the C.A.R. president last Friday about realtors joining with the firefighters to push for more tax breaks for seniors.  Thanks to Liam who explained the newly-labeled Prop 19 on Twitter yesterday, and for providing the link to the actual calculations being made to justify the changes:


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Here is the legislative analysis:

https://lao.ca.gov/ballot/2019/190479.pdf

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