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Avoiding Capital Gains Tax
By George Rehn, CPA

Practicing as a CPA in the Fire Island Professionals Office in Ocean Beach, several people have asked me about capital gains tax on the sale of their house. On May 7, 1997 the rules changed. A single person can exclude $250,000 of capital gains and a married couple can exclude $500,000. The gain is computed by taking the initial purchase price, closing costs and improvements made to the house. This amount is subtracted from the selling price less any closing costs (e.g. real estate commissions, attorney fees etc.) The gain has nothing to do with the cash that you net from the transaction. For Fire Island houses, use some tax planning which will be discussed later.

To qualify for the exclusion you must meet the ownership and use test. The individual must have owned it for two years. For a married couple only one of the spouses must meet the ownership test. Gain may be excluded if for the five year period prior to the sale, the individual or couple must have used it as a primary residence for an aggregate of two years. The last test is that an individual could not have used the exclusion in the last two years.

An individual who fails to meet the ownership and use requirements, or the minimum two-year time period for claiming the full exclusion may still be eligible for a partial exclusion when the sale of the home is due to: (1) a change in place of employment, (2) health reasons, or (3) unforeseen circumstances. According to the IRS, in order for an individual to be eligible for the partial exclusion, the individual’s primary reason for the sale must be related to one of these three reasons. Accordingly, if the individual was there only one year, a single person would exclude $125,000 and a married couple would exclude $250,000 of the gain.

To satisfy the change of employment test, the individual’s new place of employment must be at least 50 miles farther from the residence sold.

To satisfy the test for health reasons for the sale, it is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury. Obtaining or providing medical or personal care for a “qualified individual” suffering from a disease, illness, or injury, will also qualify. The term “qualified individual” is very broad and includes the owner’s spouse, as well as children, siblings, parents, and others.

To satisfy the unforeseen circumstances the following examples qualify:

1. involuntary conversion of the home

2. damage to the home from natural or man-made disasters or acts of terrorism, or

3. in the case of the taxpayer, taxpayer’s spouse, a co-owner of the residence, or another member of the taxpayer’s household:

(a) death

(b) loss of employment entitling the individual to unemployment compensation,

(c) change in employment status resulting in the taxpayer’s inability to pay housing costs and living expenses,

(d) divorce or legal separation, or

(e) multiple births resulting from a single pregnancy.

 

A sale of a residence due to the individual’s change in preference or improvement in financial position is not due to an unforeseen circumstance.

Other factors the IRS will consider include: (1) the circumstances giving rise to the sale, (2) the individual’s financial ability to maintain the property, and (3) material changes that would impact the suitability of the property as the individual’s residence.

For those who own houses on Fire Island, a recommendation is to make it your primary residence for two years prior to the sale and you’ll save a bundle! That means your activities only have Fire Island as your address. Voting, driver’s license, charities, social activities, bank accounts etc. should be Fire Island.

For any questions, stop in the Fire Island Professional Offices on Friday. Other days are available by appointment by calling 583-0268. Look for future tax articles.

Fire Island is a great place to live, work, and play. “A bad day at the beach is always better than a good day at the office,” I always say.