Given the current economic situation, a taxpayer selling their home may not be a frequent occurrence, but tax preparers should still be vigilant. Itâ€™s all too easy to look a the current mortgage rules â€“ exempting the first $250,000.00 to $500,000.00 of capital gain â€“ and forget that these rules have only been in force since May, 2007. Prior to May 2007, the old rules â€“ allowing a deferral of gain, provided reinvestment of the funds within two years â€“ were in effect.
Letâ€™s see how forgetting that fact can have an impact:
X, a single homeowner, buys her home in May, 1986 for $100,000.00. In October, 1996 X sells her home for $200,000.00, and files form 2119 to defer the $100,000.00 capital gain. At the same time, X buys her new home, for $225,000.00.
In 2008, X sells her home for $460,000.00, and heads down to Harryâ€™s Tax Service to have her taxes prepared. Harry dutifully notes that the cost basis of the home was $225,000.00, the sales price is $460,000.00 and the capital gain is $460,000 less $225,000.00, or $235,000.00. Since the $235,000.00 capital gain is less than the $250,000.00 exemption, Harry claims no capital gains tax.
Sadly, Harryâ€™s wrong, because Xâ€™s house was purchased under the old rules, and under the old rules, the basis of the new home must be reduced by any capital gain deferred. Thus, Xâ€™s basis in her home isnâ€™t $225,000.00, but $225,000.00 less the deferred gain of $100,000.00, or $125,000.00.
Revisiting the earlier transaction, Xâ€™s capital gain is now $335,000.00, or $85,000.00 over the $250,000.00 exemption amount. X might not be happy to hear that she owes capital gain tax, but itâ€™s better you tell her while preparing her return, then having her show up in your office with a CP2000 letter telling her she has a balance due of not only the capital gain tax amount, but the refund that she received!Share
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