What Is Your Capital Gains Tax Liability When You Sell Your Home?

First, a disclaimer. I am not a tax professional, financial planner, or accountant. I sell real estate, not tax advice.  However, I can tell you what I know about the above topic and urge you to verify what I say with a tax professional.

The inspiration for this column was a phone call I received from a reader who wanted to confirm that she has to buy a new house within two years in order to avoid paying capital gains on the sale of her primary residence.

Although this hasn’t been the case since the Taxpayer Relief Act of 1997, many homeowners appear to be unaware that the rules have changed, given how often I get this question. Nowadays no capital gains tax is due on the sale of your primary residence unless your gain exceeds $250,000 for an individual or $500,000 for a married couple. (Note: It must have been your primary residence for 2 of the 5 years prior to closing.)

 

That exemption has been in place now for 20 years. Prior to that, homeowners were required to reinvest in another primary residence in order to defer their capital gains tax until they finally sold without buying a new home. 

 

Your “gain” is calculated from a combination of your purchase price plus any capital improvements you made, plus the cost of selling the house. That’s called your “basis.”

 

So, let’s say that you bought a home 40 years ago for $50,000, and you’ve made another $50,000 of capital improvements (new garage, new kitchen, new bathrooms, etc.).  You just sold the house for $500,000, with a total cost of selling (commissions plus title insurance and other fees) of $25,000. Your “basis” is $125,000, so your gain would be $375,000.  If you’re married, you have a $500,000 exemption, so you owe no capital gains tax at all. If you’re single, you have a $250,000 exemption, so you’d pay long-term capital gains tax on $175,000 of your net gain. That computes to a tax liability of about $35,000. You probably had no mortgage, so your proceeds from the sale was about $470,000, and paying $35,000 in capital gains tax is definitely doable. Yes, I realize you’d prefer to pay nothing, so go ahead and marry that cute 75-year-old you’ve been dating before you sell!

 

If you sell a second home or an investment property, you do pay a tax on your full capital gain, but you can defer that tax liability by purchasing a replacement property under Sec. 1031 of the IRS Code. But this is only a deferral. Your “basis” in your current property becomes the basis for the replacement property, so you do eventually have to pay the tax (unless the tax law changes). Meanwhile, a 1031 exchange allows you to re-invest pre-tax dollars in a new piece of real estate.

 

Your purchase under Sec. 1031 does have to be for real estate, but it can be any kind of real estate.  I once had an $800,000 capital gain on the sale of an office building in Denver.  Using a 1031 exchange, I invested $600,000 of that gain in a residential rental property and paid capital gains on only $200,000.  However, when I sold that rental several years later without doing another 1031 exchange, I had to pay tax on that deferred gain, although it was reduced by the additional investment and cost of sale.

 

To do a 1031 exchange, you need to hire a “qualified intermediary,” who holds the proceeds from the sale of your “relinquished” property until you purchase your “replacement” property. This service costs upwards of $1,000, but without it, you can’t do a 1031 exchange, so it’s probably worth it. I would be happy to recommend the company I used for that process.

 

On a related matter, let me share some tax advice I received regarding passing your property on to a child or other beneficiary. (Again, I’m not a tax advisor, so confirm this with yours.) I was told you should not put your child or beneficiary on the title of your home as a “joint tenant with right of survivorship.”  Rather, you should will the home to that beneficiary. Why? Because when real estate is inherited, the basis is “stepped up” to the current market value at the time of your death. If the beneficiary is a joint tenant, he inherits your much lower basis and could owe significant capital gains tax when it comes time for him or her to sell it.

Published June 8, 2017, in the Denver Post's YourHub section and in four Jefferson County weekly newspapers.

Do You Have a Tenant-Occupied Property? Here’s Some Advice for Selling It

In today’s market, many owners of tenant occupied properties are enjoying higher then ever rental income. That’s great news if you are a professional landlord.  However, many landlords own just one or two properties. As time goes by, owning and maintaining a rental may no longer meet one’s financial needs or lifestyle.

Aside from the fact that Colorado property values have gone through the roof, there are other reasons that it may make sense to sell your rental property. Perhaps you found an opportunity in another property that makes your current rental property ripe for a tax-deferred 1031 exchange. Or maybe your rental was inherited and being a landlord is something you didn’t expect and don’t want. Or maybe you’re approaching retirement and looking to ease up on responsibilities, including those of a landlord.

 

These are just a few reasons that owners of tenant-occupied properties may want to reassess their portfolio in relation to their current circumstances.

 

Reviewing your rental agreements would be the best first step before moving forward. Tenants have rights which may or may not affect your immediate plans. In reviewing your agreement you should be able to determine your options and map out a timeline for what you need to do and when.

 

Colorado has two types of leases. “Periodic Tenancy" (usually referred to as “month-to-month”) is a rental agreement for a one-month period that is renewed automatically each month until terminated by either party. Proper notice for both landlord and tenant must be written and received by the other party at least ten days before the last day of the rental month. However, a written month-to-month lease may specify a longer notice period — for example, 30 or 60 days before the end of the lease term.

 

If a lease is for a period of time with a definite ending date (usually specified in years), it is a “Term Tenancy” or “Definite Term” lease. When the lease expires, the tenant must either renegotiate a new lease or stay on as a month-to-month tenant, but only with the landlord’s express consent. Neither the landlord nor the tenant needs to give notice of termination at the end of a term lease unless the lease requires such notice.

 

If you have decided that the time is right to sell your rental property it may be in your best 

financial interest just to hang on and wait for the lease to expire or terminate the rental agreement as allowed by state law.

 

Denver metro area property values are still appreciating, so your equity is increasing as you wait it out. Also, having the opportunity to inspect, repair, repaint and freshen up your property before listing it for sale should pay dividends. This can reduce the stigma of buying a former rental. If you list your property with Golden Real Estate, not only will you receive a free staging consultation to make your property show its best, you also get free use of our moving truck. The overall advantage is that you should expect to get more for the property than if it was still tenant occupied. Also, more buyers could view the vacant property, increasing the possibility of competitive bidding.

 

The other approach would be to enlist the help of the tenants through enticements and bonuses for their willing participation in helping you sell your property faster and possibly avoiding any loss of potential equity. Certain previously mentioned scenarios may call for speeding up the date you need to sell, including pursuit of a desired 1031 exchange opportunity. Selling the property might also put you in a position to purchase a home you like that just came on the market.

 

Gaining the cooperation of the current tenant is critical when putting a rental property on the market. First, I arrange to meet with the tenant and find out if they want to stay, while also assessing how they maintain the unit. They are likely concerned about whether the home will be sold to an owner-occupant and they’d be forced to move. If they want to stay, I tell them we have priced the home with the intention of getting multiple offers, and I’ll do my best to have the winning bidder be an investor who likes the idea of a tenant in place. I also offer free use of our moving truck if they do have to (or want to) move. Hopefully these promises inspire them to be cooperative during what we anticipate will a short listing and showing period. Our intention is to make it a win-win situation for the seller, the buyer and the tenant.

 

Andrew Lesko, a broker associate at Golden Real Estate, assisted me with the writing of this article. You can reach Andrew at (720) 550-2064 or by email at   Andrew@GoldenRealEstate.com. He’s our condo and townhome specialist. Andrew created a terrific website detailing 30-plus condo and townhome communities in the greater Golden area. Check it out at www.GoldenLifestyleProperties.com

 

Published May 25, 2017, in the Denver Post's YourHub section and in four Jefferson County weekly newspapers.