DEAR BOB: My husband owned his home when we met and later married. We sold that home in 1993 and “rolled over” the profit into our current home. We are now thinking of selling our current home. How does the new law you often discuss apply to us? – Christine M.
DEAR CHRISTINE: Thank you for bringing up an often-overlooked aspect of wonderful Internal Revenue Code 121.
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As you probably know, IRC 121 allows up to $250,000 (up to $500,000 for a qualified married couple filing jointly) tax-free, principal-residence sale profits. To qualify, you must own and occupy your principal residence an “aggregate” two of the five years before its sale.
Congress enacted IRC 121 in 1997. However, under the old, now-revoked IRC 1034, your husband deferred capital-gain tax on the sale of his previous principal residence by purchasing a replacement principal residence of equal or greater cost. Amazingly, many people think that old rollover tax law is still in effect today. Just last week, I received a letter from a reader asking why I never write about old IRC 1034.
Back to your question, your adjusted cost basis for the current home is its purchase price, minus the amount of deferred capital gain from the sale of the previous home, plus any capital improvements added during ownership.
For example, suppose you and your husband paid $200,000 for your current home. But imagine there was $75,000 deferred “rollover” capital gain from the sale of the previous principal residence. That means your adjusted cost basis for your current home is, not $200,000, but just $125,000. To that amount, please add the cost of capital improvements you added during ownership. The result is your current adjusted cost basis.
To determine your present home’s capital gain upon sale, subtract its adjusted cost basis from your adjusted sales price (gross sales price minus selling costs).
You can then use IRC 121 to qualify for up to $500,000 (up to $250,000 for a single principal-residence seller) tax-free profits. There is no longer any need to buy a replacement principal residence, as there was under the now-revoked IRC 1034. Ask your tax adviser for further details.
WILL GIFT TAX BE DUE ON BELOW-MARKET HOME SALE?
DEAR BOB: I was going through some of your old columns recently. I ran across an item that raised my eyebrow. Someone asked about the tax implications of selling his $490,000 house to his son for its adjusted cost basis of $260,000 so he wouldn’t owe any capital gains tax. You said there is no tax law requiring the sale of a home for its full market value. Clearly, you are right. But wouldn’t there be a gift or estate tax implication? Presumably, the difference between the home’s fair market value and the sale price can be considered a gift (minus the $11,000 annual allowable tax-free gift per donee). It seems like this a huge loophole around the gift and estate tax? – Jim C.
DEAR JIM: I am honored you clip and save my articles. As you obviously know, anyone can give away up to $11,000 annually per donee without any gift tax consequences. Over $11,000, however, a federal gift tax return must be filed even if no gift tax is due.
In the situation you describe, where the parent sold a property worth $490,000 to a child for its cost basis of $260,000, it is arguable the $230,000 difference is a gift.
However, no federal gift tax will be due if the donor’s total lifetime gifts exceeding $11,000 each did not surpass the current $1 million lifetime federal gift-tax exemption. For full details, please consult your tax adviser.
WHAT IF NEIGHBOR DIDN’T OBTAIN A CITY GRADING PERMIT?
DEAR BOB: We have a neighbor who raised and leveled her rear yard two years ago. Now the neighbor’s house looks down into our yard and home. If this was done without city grading permits, what recourse do we have to fix it? – John B.
DEAR JOHN: Shame on you for not raising the issue while the work was being done. A simple phone call to your city or county building permit office would determine if the neighbor had the proper permit to grade their property.
I had a similar situation with a neighbor over a year ago. He hadn’t obtained the proper city permit to change the drainage on his property. I was concerned his work might affect my downhill property. The city issued a “cease and desist” order and made him submit his plan so my property would not be adversely affected.
Unless your property is suffering damages, at this point you probably have no legal recourse. Just because a neighbor can look down on your property doesn’t give you any legal recourse unless you can prove actual damages. For more details, please consult a local real estate attorney.
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