Capital Gains Strategy For Long-Term Homeowners
I'm speaking to those of you who have lived in the homes you purchased 15 years ago or longer. And, yes, I'm addressing you "baby boomers" and any others who have lived in their homes for a long time and who may be looking to move down" or "move-up" at some point in your lives. When you bought your personal residence, the price you paid for your home will serve as your unadjusted basis for purposes of calculating the Capital Gains Exclusion on your home if and when you ever sell the home. You adjust that basis for capital improvements - see below. And, as you probably know, the current capital gains exclusion is $250,000 for a single person or $500,000 for a married couple.
Back in 1997, when the Taxpayer Relief Act of 1997 became law, the home-sale tax burden eased for millions of residential taxpayers. The rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts. If you used pre-1997 rules for residential sales, don't worry. That doesn't disqualify you from claiming the exclusion on any residential sales now. The law change applies to all sales since it took effect.
Another bonus of the new rules: You don't have to buy another home with your sale proceeds. You can use the money to travel to Europe in style, buy an RV and drive across the country. Even better, there's no limit on the number of times you can use the home-sale exemption. In most cases, you can make tax-free profits of $250,000 (or $500,000 depending on your filing status) every time you sell a home.
Ah, but we are talking taxes here. You did notice that phrase "in most cases," didn't you? There's always a catch. Before you put a "For Sale" sign in the yard, you need to make sure your house-sale situation is one of those "most cases." First, the property you're selling must be your principal residence. That means you live in it or have lived in it for at least two of the last five years. This tax break doesn't apply to a house or other property that you have solely for investment purposes. In those cases, the usual capital gains rules apply.
You can, however, turn a rental house into your primary residence, making the sale of it eligible for the exclusion. This is accomplished when you meet the IRS use and ownership tests. You own and live in the home for two out of the five years before the sale. But there's a way to shelter even more than the $250,000 or $500,000, whichever the case for you - if you keep good records of home improvement projects which adds to your home's cost basis.
This matters for any homeowner with—or wishing for one day– an outsized gain. It’s all the more important since Jan. 1 now that the top capital gains tax rate is 20% for folks in the top income tax bracket, and there is an additional 3.8% Obamacare surtax that applies if your income is over $200,000 for a single or $250,000 for a couple. (The taxes apply to the gain on your home sale that’s above the basic home sale exclusion amount). Plus, with tax reform on Congress’ agenda in Washington, you never know if the home exclusion break will be tinkered with again. It was just 2008 when Congress put in limitations so that a landlord couldn’t move into a rental property for two years, call it home, and snag the full break; instead the home sale exclusion is pro-rated for the years the house is rented.
It’s difficult for most people when they go to sell their home to come up with the cost basis. They remember what they paid for it, but it’s cumbersome to add up all of the improvements they’ve made over the years. Tedious for sure, but it can pay off big. And there are definitely lots of folks who should be keeping track–older homeowners replacing aging infrastructure (plumbing, roofing) or younger homeowners putting in new designer kitchens. You need to have records (receipts and credit card or bank statements) to prove your home’s adjusted basis. The Internal Revenue Service details this in Publication 523, which gives examples of improvements that increase basis (they must have a “useful life” of more than a year) and distinguishes them from repairs that don’t. Improvements include a bathroom addition, landscaping, a sprinkler system, a soft water system, central air, new flooring, a satellite dish, an alarm system and attic insulation.
Repairs, by contrast, maintain your home in good condition but do not add to its value or prolong its life, so you don’t add them to the costs basis of your property. Repainting your house or replacing broken windows count as repairs. The one way repairs can count towards your cost basis is if they are done as part of an extensive remodel. Keep track of everything, But don’t be greedy. Towels don’t count.
Did you know that certain people can "buy down" while retaining their Prop 13 base-year value of the original property for property tax purposes? Here's some of the important requirements toward achieving this:
- You OR your spouse must be 55 years of age or older when you sell your original residence;
- Your replacement property must be located in the same county in California as the original residence (see exceptions below);
- The replacement residence must be equal to or lesser in market value than the original residence is currently. What is meant by "equal or lesser value" than the original dwelling? In general, "equal or lesser value" means:
100 percent of the market value of an original property if a replacement dwelling is purchased before the original property is sold.
105 percent of the market value of an original property if a replacement dwelling is purchased within one year after the sale of the original property.
110 percent of the market value of an original property if a replacement dwelling is purchased within the second year after the sale of the original property.
- The replacement residence must have been (a) receving or eligible for a Homeowner's Exemption, or (b) have been receiving a Disabled Veteran's Exemption on the original and replacement residences;
- This benefit is only available once in a lifetime;
There are some counties that will accept the property tax base of the original property that is outside of their county so long as the original property is within the State of California. Those counties are: Alameda, Los Angeles, Orange, San Diego, San Mateo, Santa Clara and Ventura Counties. Other counties will only allow replacements to be within its own county.
Re-written on 4/30/2014 by Gary Civello
The basic reason why people lease is because the upfront payment and the monthly rental is usually less than that which you would pay if you obtained a vehicle using a straight loan. The second reason is that people are more comfortable with "writing-off" the business supported operating cost of a lease than to take depreciation on an owned vehicle. Those two reasons aside, you should consider that a lease is not a great deal different than a loan. It is a form of financing. Yes, you don't actually own the vehicle but you do have similar if not identical control. Let's say this differently. Let's say the dealer said to you "You can buy the car and the manufacturer will agree to buy the car back from you in 36 months at a predetermined price (residual) equal to the then existing financing payoff so long as the car does not have over 36,000 miles. At that time, you can (a) either sell the manufacturer the car at that price thereby using the proceeds of the sale to payoff the financing and thereby allowing you to walk away, or, (b) you can continue to pay the monthly payment for up to a year by extending the lease, or, (c) you can find a buyer and keep the difference between what they agree to pay and the remaining balance of the financing (same as the residual), or, (d) you can keep the car indefinitely and pay off the balance of the financing - same as the residual". Saying it that way, it seems as though your options are similar to ownership. And, you know what? They are the same.
Once you understand that leasing is not some suspicious way to get you to pay for something that you don't own, you can get down to the basics. There are two important elements - the money factor and the residual. The dealer will quote you some mysterious factor that sounds something like "point zero zero something". I'm going to use a real case situation for sake of clarity. I assisted a client of mine who was acquiring a 2007 Honda Accord EXL-V6 3.0L Sedan with Navigation. That car has all the bells and whistles and doesn't need anything else. As a matter of fact, I don't thing there were any options to be had. That car has a MSRP of $29,995 and the negotiated price was $26,339. The quoted factor was point zero zero zero nine - .0009. What is that you ask? Well, that is actually the nominal rate of the financing. You would simply multiply the factor by 24 to get the actual nominal financing rate. In this example, the rate is 2.16% (.0009 x 24). The other important element is the residual which in this case was 56% based on the included mileage requested. That residual is applied to the MSRP - not the negotiated sales price. So, the larger the discount that you are paying, the lower the factor and the higher the residual, the lower the amount of down payment and monthly payment you will have to pay. There are other items of note including an "acquisition fee" that is not usually present in loans. That amount varies from car to car but the acquisition fee was $595 on this particular vehicle. With all taxes (including local sales tax rate of 8.25%), license, titling, registration, and doc fees, this vehicle went out the door for $3,000 drive-off and the monthly payment was $277 for 36 months and no security deposit had to be paid.
Now, if one wished to purchase finance this vehicle over 60 months and you could get a rate of 1.9% from the manufacturer and you want to put down the same $3,000, the monthly payment would approximate $450. So, the lease actually saved my client $173 per month and left her with a boatload of options at the end of the 36 month lease term. Clearly, you would not be building up as much equity in the car, but, why does that matter that much? Some would say save your money for investments. Cars are not investments. Anything that depreciates as a normal occurrence is not an investment. My advice - invest in things that appreciate not in things that depreciate.
To properly reconcile the two forms of financing, the loan would have about $10,600 of unpaid principal balance remaining after 36 months. The residual on the lease would approximate $16,800. The difference is about $6,200 of equity that could have been built up under the loan that didn't build under the lease. However, the $173 monthly savings under the lease would derive about $6,700 if placed into a 5% money market account. So, when you compare the two financings in this manner, they truly are very similar. Hence, the argument that leasing is just another form of financing.
When inquiring about a lease, you will have to tell the dealer the term and yearly mileage that you wish to have as part of the lease. Also, you should know your credit score. Once you know these, you can ask for the following: money factor, residual, security deposit (usually nothing if credit is good), acquisition fee, registration & titling and doc fees. From there, you can actually derive your own spread sheet to determine the cost. The negotiation of the selling price of the vehicle is a separate issue not unlike your normal negotiation of price when buying for cash or getting a loan.