By: Martin M. Shenkman, CPA, MBA, JD
Home Tax Question
We are trying to understand the possible home sale exclusion for our sale of our home. Even though the house is in generally new condition, we put in a substantial amount of our own labor to making renovations. We estimate that we will have about $220,000 of capital gains on the sale. At what point are we considered the “owner” for tax purposes? When does the time period during which we can avoid capital gains by qualifying for the home sale exlcusion begin and end? We have owned our prior home for 12 years. We built a new home starting in summer 2009, but it took a number of months to complete. We obtained a construction loan March 2009. We took occupancy of our new residence home in April 2009. We could not sell our old home for quite a while and only were able to close a deal in August of 2010. What qualifies as the two year time period for home sale exclusion rules? My spouse’s job position is uncertain and it appears that we may have to move again in the next few months if she finds a new position in another town in couple months. What other issues might apply?
The answer is not simple. A host of issues are raised by the question. Given the many nuances to each, it is really strongly recommended that the questioner review the general answers below with his or her own CPA before taking any action.
Home Sale Exclusion on Old Home
Law: A taxpayer can exclude from income up to $250,000 of gain ($500,000 for joint filers meeting certain conditions) from the sale of a home owned and used by the taxpayer as a principal residence for at least two of the five years before the sale. In general, the full home-sale exclusion applies only if the taxpayer owned the home and used it as a principal residence for at least two of the five years ending on the date that it is sold. Code Sec. 121(a).
Application to Readers: The taxpayers owned their home for 10 years through its sale in August 2009. They occupied it as a principal residence through February 2009 when they moved into their new home. It appears that they readily met the two of five year requirement.
Gain from the sale or exchange of property that is attributable to periods of “nonqualified use” is not eligible for the exclusion. Code Sec. 121(b)(4)(A). “Nonqualified use” refers to any period after 2008 during which the property is not used as the principal residence of the taxpayer, or his spouse or former spouse. ( Code Sec. 121(b)(4)(C)(i). If they rented the old house pending sale or used it for business that could be a non-qualified use.
The gain to exclude on any sale is the proceeds of sale less the taxpayers’ tax basis in the home sold. These readers put a lot of their own labor into the construction of the home (not clear if this applied to old home sold, or new home or both). They cannot treat the value of the labor they provided as part of the tax basis, even if they can corroborate it and even if the taxpayers were in the construction business. Had they paid a third party to do the construction, it would have been included in their tax basis. They should carefully document their tax basis correctly to avoid any issues.
Construction Loan Refinance and Home Mortgage Interest Deduction
Application to Readers: The readers took out a construction loan. The home mortgage interest rules are tough. If they refinance for more than the cost of the construction, they may be limited in how much mortgage interest they can deduct. For example, they may have purchased materials and provided their own labor, so when construction was complete, the home was much more valuable than the amount of the construction loan.
Law: Acquisition indebtedness is debt secured by a qualified residence (including a designated second residence) not exceeding a $1 million ceiling ($500,000 for married filing separately). Acquisition indebtedness proceeds must be traceable to expenditures to acquire, construct, or substantially improve a qualified residence. Interest expense on acquisition indebtedness is fully deductible as qualified residence interest [ IRC Sec. 163(h)(3)(B)]. Acquisition indebtedness includes debt used to refinance earlier indebtedness meeting the definition of acquisition indebtedness, but only to the extent of the original acquisition indebtedness. For AMT purposes, interest expense from refinancing debt is deductible only to the extent the amount of the loan principal is not increased.
Too Many Home Sales Too Soon
Application to Readers: They may not qualify for a home sale exclusion if they sell again.
Law: The home sale exclusion shall not apply to any sale or exchange by the taxpayer if, during the two-year period ending on the date of such sale or exchange, there was any other sale or exchange by the taxpayer to which subsection (a) applied. IRC Sec. 121(b)(3).
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