Call them migrant taxpayers, tax nomads or just smart and mobile.
Glenna and Rick Sansone are selling their home and high-tailing it across town, where they plan to live for precisely two years before they move again. And again. And again. Why? Taxes — or, rather, the absence of them.
The Sansones own a home and two rental properties in and around Carmichael, Calif. That gives them the opportunity to trigger tens of thousands of dollars in tax-free income every two years, thanks to a 1997 tax law.
“Congress gave us an incredible gift,” Glenna says. “We’re going to take it.”
Indeed, three years ago Congress changed tax laws relating to the sale of personal residences. Before that point, taxpayers could delay recognizing the gain on the sale of a personal residence only as long as they were willing to buy a replacement residence of equal or greater value.
But as part of the Taxpayer Relief Act of 1997, taxpayers were allowed to exclude up to $250,000 per person ($500,000 per couple) in profit from the sale of a personal residence from tax.
If you’re selling a house for less than the exclusion amount, this is a breeze tax-wise. Your lender won’t even send you a 1099 form saying you got this money because it’s not taxable.
If your sales price is more than the exclusion amount, it can get tricky because then you have to show the IRS what portion of the proceeds are profit — taking into account all your profits from previous sales that you deferred under the old rules.
There are basically two caveats to the exclusion rule: To qualify for the exclusion, you must have lived in the home for at least two of the previous five years. And if your profit exceeds the exclusion amount, you must pay tax on the excess amount — regardless of whether or not you buy a replacement property.
That means people sitting on huge gains in very expensive homes are likely to owe income tax when they sell. But owners of more moderately priced homes who want to sell out, trade down or convert rentals into residences can trigger substantial tax-free profits.
The Sansones are a prime example. Rick, a high school guidance counselor, builds houses during the summers when he’s off work, which is how he’s accumulated those two rental properties. He plans to start construction on another in June.
Because he builds himself, his cost in the homes is relatively low. He figures he’ll earn about a $60,000 to $70,000 profit on his current house, which is listed for $195,000. And the rental the Sansones plan to move into is likely to generate an even bigger profit when they sell it two years down the road, he says.
If all goes well, Rick will retire from counseling and build and sell houses for a living. As long as they move into the houses for two years before selling them, the bulk of the income will be tax-free.
“They’ll be nomads but trying to generate all of their income tax-free,” says Philip J. Holthouse, partner at Los Angeles tax accounting firm Holthouse Carlin & Van Trigt. “It’s the American dream.”
Naturally, the Sansones are unusual. Not only can they build houses themselves, they’re also willing to move much more frequently than the average homeowner. But anyone who wants to sell a valuable rental or vacation property ought to consider the benefits of moving into it for two years. Such moves can save a fortune, Holthouse says.
As an example, a couple with a $500,000 profit on a vacation home would save $100,000 in federal tax, at the long-term capital gains rate of 20 percent, by making it their residence for two years.
If a rental property has been depreciated, as most are, the net tax break will be somewhat less because you’ll have to pay tax on any depreciation that you’ve claimed since 1997, Holthouse says. However, the savings are still likely to be substantial.
Better yet, if you are selling a home for less than the tax exclusion amount, the 1997 law not only gives you tax-free income, but it also saves you time. That’s because previous law required that you keep records of every home purchase and sale for which you deferred a gain.
Those records would ultimately be used to determine your cost in the current home. If you chose to trade down by buying a less expensive home or wanted to sell out and not purchase a replacement property, you’d need those records to determine the profit — all of which would be taxable.
Under the new law, if your residence sells for less than $250,000 (or $500,000 if you’re married), there’s nothing to report or calculate. Generally, the only time you need to keep records on improvements or a sale is if your house is (or might eventually be) worth more than the exclusion amount.
If you own a more expensive residence, you’ll need to keep records of the home’s purchase price, as well as the cost of any permanent improvements you make. (Permanent improvements would include adding a pool or an extra bedroom or remodeling a kitchen or bathroom, but would not include the cost of repairs and maintenance, such as repainting.)
If your net profit on the residence, after subtracting the purchase price and the cost of permanent improvements, is more than $250,000 if you’re single or $500,000 if you’re married, you’ll pay capital gains tax on the difference.
COMPARING THE RULES
Here are a few of the key differences in the old and new tax laws governing home sales. If you haven’t sold your home since the new rules passed in 1997 and you own an expensive home — worth more than $250,000 if you’re single, $500,000 if you’re married — you need to be aware of both rules. That’s because your net profit must be determined based on the old rules and the amount you exclude from tax is based on the new rules.
– Old law: You could defer paying tax on any profit you earned on the sale of your personal residence as long as you bought a replacement property of equal or greater value.
– New law: You can exclude up to $250,000 per person ($500,000 per couple) in gains on the sale of your personal residence from federal tax. You must pay tax on any excess amount, regardless of whether you buy a replacement residence.
– Old law: There was no specific amount of time that you had to have lived in a house for it to be considered your personal residence.
– New law: For a house to qualify as your personal residence, you must have lived in it for at least two of the last five years.
– Old law: You needed to keep records detailing your profit (or loss) every time you sold a home and rolled the gain into the purchase of a new residence (if you haven’t sold your house since 1997, you still need those records). If you eventually didn’t buy a replacement property of equal or greater value, you’d have to pay tax on any portion of your net profit that wasn’t rolled into the purchase of another home.
– New law: If you’re selling for the first time since the Taxpayer Relief Act was passed in August 1997, you still determine your gain based on the old rules. But single filers get to exclude $250,000 of the profit from tax, and married couples can exclude as much as $500,000 of the profit.
Once you’ve sold one home under the new rules, you need to keep track of only your cost in your current residence. Each residence sale is taxed independently. If your gain is less than the exclusion amounts, there’s no tax. If it’s over the exclusions, you pay tax on the excess profit.
— Kathy M. Kristof
