CALIFORNIA REAL ESTATE UPDATE #2

INTRODUCTION

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TEST YOUR KNOWLEDGE ON SAVING TAXES WHEN YOU SELL A HOME

This issue is designed to inform everyone about IRS rules concerning the sale of a personal residence. We find that many homeowners are not aware of some of the nuances and tax saving possibilities. It is presented as a test so you can evaluate your knowledge. Read and answer the questions and then review your answers at the end of the test.

1. If I want to find information about a tax-deferred exchange, I read IRS Code Section 1031. Which section has information about the sale of my home:

   1. 1034
   2. 121
   3. 1031
   4. None of the above.

2. The new exclusions of gain are $250,000 for a single taxpayer and $500,000 for a married couple. How long does a taxpayer have to own and live in a home or condo to receive the exclusion?

   1. 5 years
   2. 2 of the last 5 years
   3. 10 years
   4. 1 year

3. If a person has to sell and move after one year and they had not used this exclusion in the past year, they can get a proration of the exclusion by reason of:

   1. Change in place of employment.
   2. Health.
   3. Unforeseen circumstances.
   4. All of the above.

4. A gain on the sale of a taxpayer's home in a foreign country can be excluded:

   1. Only for diplomats.
   2. Never.
   3. If owner lives and works there.
   4. None of the above.

5. The new exclusion can be used:

   1. Over and over if qualified.
   2. Only once.
   3. Only if over 55 years of age.
   4. Only 3 times.

6. To qualify for the change of employment proration your new workplace must be _____ miles farther from your old residence than your old workplace.

   1. 50
   2. 25
   3. 0
   4. None of the above.

7. A couple to get their home ready for sale spends $3,000 to paint, $2,000 to repair a roof, and $2,000 to clean up a yard. These costs are:

   1. Added to basis to reduce gain.
   2. Added to selling expenses to reduce gain.
   3. Automatically a buyer's responsibility.
   4. Forgotten for tax purposes.

8. If a residence is sold for more than the purchase price plus improvements, the transaction must be reported to IRS:

   1. On a form 2119 by the taxpayer.
   2. By the escrow office handling the sale.
   3. Only if there is taxable gain.
   4. Never.

9. A couple lived together for two years and had not ever used this exclusion. The woman owned the residence separately. On the last week of the two year period, they got married and filed a joint return.

   1. They qualify for the $500,000 exclusion.
   2. The new wife gets a $250,000 exclusion only.
   3. The new husband gets only a prorated exclusion.
   4. None of the above.

10. The couple in Question 9 moves to a jointly owned home and rent the first property for 2 1/2 years. They sell the first property 2 1/2 years after moving out:

    1. The first property became a rental and doesn't qualify for the exclusion.
    2. The first property qualifies for the full exclusion.
    3. Both a and b.
    4. None of the above.

11. If you grant an option in a home to a buyer for $1,000 and it expires:

    1. Never a tax on the money.
    2. Gain is reported in the year the option expires.
    3. You subtract the total from your base.
    4. Gain is reported in the year the option was granted.

12. For more information about these regulations an outstanding "free" source is:

    1. Ernst & Young Tax Guide.
    2. IRS Publication 523.
    3. A course from Duane Gomer.
    4. An interview with your tax advisor.

13. You bought a house five years ago for $300,000 and built a pool for $50,000 and due to a job change, you had to sell a net price of $330,000.

    1. The loss is deductible.
    2. The loss will be added to you next purchase.
    3. There is an excluded gain of $30,000.
    4. The loss is $20,000 and is not deductible.

14. The IRS formula for calculation of gain is:

    1. Sales Price - Loans = Gain.
    2. Sales Price - Basis = Gain.
    3. Sales Price - Basis - Loans - Selling Price = Gain.
    4. Sales Price - Selling Expense = Amount Realized - basis = gain.

15. A main home could be a:

    1. Houseboat.
    2. Mobile home.
    3. Recreational Vehicle or Coop Apartment.
    4. All of the above.

16. If you pay Real Estate taxes of the seller, when you buy a home, the amount is:

    1. Added to your basis.
    2. Forgotten for tax purposes.
    3. Subtracted from basis.
    4. Deductible by you as real estate taxes paid in year of purchase.

17. If you built your own home, you add to basis:

    1. The value of your labor.
    2. Fees for getting a loan.
    3. Building permit charges.
    4. None of the above.

18. If you inherit a property, your basis could be its fair market value::

    1. On date of death.
    2. On later alternate valuation date.
    3. Less any loans on property.
    4. A & B above.

19. You and your spouse sell a "qualified home" for a gain of $600,000 for nothing down and carry back a note.:

    1. You are taxed in year of sale for $100,000.
    2. Will never be taxed.
    3. You exclude $500,000 per section 121 and the remainder as an installment sale.
    4. None of the above.

20. The basis is some homes is lower than owners think because:

    1. They made a Section 1034 sale when they bought the home.
    2. Depreciation taken while a rental.
    3. They got property as a gift.
    4. All of the above.

ANSWERS and EXPLANATIONS

1. B.  Section 121. Before the 1997 Tax Change the information was in Section 1034, and Section 121 discussed the over 55 years of age exclusion. That $150,000 exclusion was eliminated in the new law and the new regulations about the sale of a home were positioned in Section 121, and Section 1034 is no longer effective.

2. B.  A taxpayer must own and live in a home for 2 of the last 5 years so most homeowners who buy and move in about the same time qualify in just two years. Also, to qualify, taxpayers must not have used this exclusion for two years.

3. D.  For example, if a single taxpayer owned and used a home for only one year and his or her place of employment changed, he or she would get an exclusion of $125,000.

4. C.  Statement of fact from the Code. However, a 1031 Tax Deferred Exchange is not allowable on any foreign property. Incidentally, the Code reads, "unforeseen circumstances according to regulations". No regulations have been written to define these terms.

5. A.  You can do it every 2 years like clockwork. You could move in, do a major rehab, sell and make a gain and do it again.

6. C.  The new change of employment rule doesn't specify any mileage requirement. Under prior 1034 rules, it had to be 50 miles farther and that is still the requirement if you want to deduct moving expenses from your income on a job change.

7. D.  These costs were formerly called fix-up costs and were used to calculate how much a taxpayer had to pay for a new home to defer all of the gain on a sale. Now, they are forgotten and are considered expenses and not improvements. If a person "improves" a residence (adds a pool, thermal windows, room addition, more efficient water heater, etc.) those costs would be added to the basis and would reduce any gain.

8. C.  Statement of fact from code. A and B were both required under pre-1997 regulations.

9. A.  Both taxpayers must use the home but only one spouse needs to own if they file a joint return. It doesn't state how long you must be married. By the way, this means that for two unmarried persons living together to get the total exclusion, both would have to live in and both be on title for two years. Then, they would each qualify for a $250,000 exclusion.

10. B.  Yes, you can move out and rent for up to three years and still get the exclusion. This couple would be getting "tax excluded" gain on two houses for the 2 1/2 years. Great tax planning. Then, they could wait two years after the sale of home A and sell home B. However, after 2 years in home B, they could have bought and moved into home C and rented home B and keep building "tax excluded" gain in two homes.

    One last thought: You have a rental property that would generate a $500,000 gain if sold. How about doing a 1031 Tax Deferred Exchange to a nice home and then rent this home long enough so it would qualify as a rental. Then, you move in for two years and it becomes a residence and qualifies for the total exclusion. You could sell and the tax on the $500,000 is never paid. This is a recommended procedure to get gain from rental, investment property, or vacation homes to be excluded when sold. Excluded gain is always better than Tax Deferred gain.

11. B.  Right out of the code. If the option is exercised the amount is added to the Sales Price for the seller and basis for the buyer. If the option isn't exercised on a property, the buyer will move into a home, the amount is forgotten. If it will be a rental home, it can be deducted as a business loss.

12. B.  IRS publications are outstanding. For copies, go to www.irs.gov and get a complete list. The other three answers are excellent and correct but they are not "free" sources.

13. D.  The loss is $20,000 and a loss in the sale of a residence or main home is never deductible. Any loss on the sale of a rental home would all be deductible in the year of sale. Could you convert the home to a rental and sell it for $330,000 and take a loss? When you convert a home to a rental, your basis is the current basis or fair market value at time of conversion whichever is lower. Therefore, when it becomes a rental, your basis becomes $330,000 immediately. So if you sell there is no loss if you sell for a net price of $330,000.

14. D.  This is the official IRS terminology. I would rephrase it to Net Sales Price - Basis is gain. Some people confuse the IRS term of Amount Realized with the common term of Net Proceeds. Not the same.

15. D.  The definition of a main home is rather broad. A main home is the home you live in "most of the time". The items listed all qualify if they have cooking, sleeping and restroom facilities.

16. A.  You can't get a tax deduction by paying any taxes for which the seller is obligated. Good try. On my first purchase many years ago, I thought I had made my down payment tax deductible by paying a large amount of back taxes of a seller. Not so.

17. C.  You labor ("sweat equity") is never added to basis. You pay someone $20,000 to do plumbing it's added to basis. You do the plumbing and it is forgotten. When you sell, your basis will be $20,000 lower so if the sale is taxable, you are paying capital gains tax on your sweat equity.

D.  When a property is inherited, the basis is calculated as of time A or B. This is great. You own a piece of land for which you paid $1,000 years ago. The value now is $100,000. If you sell, you have a large gain. If you die and someone inherits the property, there would be no gain on an immediate sale. A good rule to remember -- Loans don't affect basis. Dying can be good tax planning.

18. C.  yes, you can combine the benefits of the home gain exclusion and an installment sale. Look for my future training exam on seller financing and the outstanding benefits to both sellers, buyers and lenders. Installment sales of this type are not used enough.

19. D.  many owners are amazed. When they sell a home and their gain is much larger than they expected because of a low basis. Before May 7, 1997, many homes were sold and the gain transferred to the new purchaser thus lowering the basis in the new home. If anyone has owned the same home since May 7, 1997, they should check with their tax advisor to verify their basis. It would be in the Form 2119 prepared that year to make their sale non-taxable.

    Also, any depreciation taken if a present main home was ever rented or used partly as a business office, the basis would be lower.

    If a property was received as a "gift" and not inherited, they could be a major problem. Check question 18 again. If the owner gifted the property to someone before death, the basis for the new owner would be $1,000. basis follows a gift. That statement is so important I shall be redundant. Basis follows a gift.

    Want to hear a few more tax laws about homes? Well, I'll tell you anyway.

    If you abandon a property and the lender forgives your loan, you have ordinary income in the year of forgiveness. Forgiveness of debt is taxed as ordinary income.

    If you are foreclosed out of a property, the sales price at the Trustee Sale is your Amount Realized to calculate gain. Much better than abandonment but could still be a problem.

    If you have a low basis and refinance for a larger amount than the basis, you could have ordinary income at the time of a sale or foreclosure. Loss - Basis = Problem if a the results is a positive number.

    If your home was destroyed or condemned, any gain qualifies for the Section 121 exclusion. Any gain in addition to the $250K / $500K limit could be postponed by buying another home within certain time guidelines. For more information, see IRS Publication 547 if a home was destroyed or IRS Publication 544 if a home was condemned.

    You can exclude gain on the sale of a remainder interest (life estate for example) in a home but not if you sell to a related party such as relatives or certain organizations and trusts.

    And you thought selling a home was simple.

    Thanks for testing and reading. Remember Duane Gomer, Inc., your one-stop source for Real Estate Education, Information and Training.

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