FOR IMMEDIATE RELEASE: May 1, 2006

HOMEOWNERSHIP: THE TAX IMPLICATIONS OF TRADING DOWN

Is it time to trade down to a smaller home? That’s a question more and more homeowners – particularly baby boomers – are asking themselves. Whether you’re thinking about downsizing because you are facing financial or health issues, have recently become an empty nester or are just tired of maintaining a large home, be sure to take the time to understand the tax rules. The New York State Society of CPAs provides the following overview.

TAKING ADVANTAGE OF TAX-FREE GAINS

When you sell your primary residence, you can generate a gain of up to $250,000 ($500,000 if you file a joint return) and not owe any capital gains tax. There is no age requirement and no need to buy a more expensive home to qualify for this exclusion. As long as you meet the IRS requirements, the tax-free gain is available even if you choose to buy a smaller home or to rent one.

QUALIFYING FOR THE EXCLUSION

To qualify for the exclusion, the home you sell must be your principal residence, and you must have owned and lived in it for at least two of the five years prior to the date of sale. That doesn’t mean you need to be living in the home when you sell it.

For example, suppose you lived in your primary residence for two years, and then relocated to your second home for the next three years before selling your main home. Since you lived in your primary residence for two of the five years prior to the date of sale, you meet the IRS’s requirements.

If you own both a primary residence and a vacation home, you may need to plan ahead. Depending on which property has appreciated more in value since the time you bought it, you might want to take steps to qualify that property as your principal residence. This way, you shelter the larger capital gain from taxes. Since there is no limit on the number of times you may qualify for tax-free gain, you may have another chance to reap the tax benefit when you sell your remaining home. The only requirement is that the sales be at least two years apart.

EXCEEDING THE TAX-FREE LIMITS

If you’ve owned your home for a good while, it’s possible that its value has increased beyond the $250,000/$500,000 tax-free thresholds. Any gain that exceeds the exclusion threshold is taxed as a long-term capital gain. For most homeowners, this is 15 percent, but could be as low as five percent, depending on the taxpayer’s taxable income.

Even if you have a gain that exceeds the threshold, don’t assume that you owe tax on the entire amount above the thresholds. Chances are that over the years you’ve improved your home, perhaps by adding a deck, another bathroom or new landscaping. According to tax law, the cost of additions and other improvements that add to the value of your home or prolong its useful life increase the basis of your home, which reduces your gain--and your tax bill.

MOVING ON

CPAs recommend that individuals who are downsizing give careful thought to their options and consider the financial implications of each. For example, if you plan to buy a smaller home, should you pay cash or take out a mortgage? While it may be appealing to not have a monthly payment, taking out a mortgage could allow you to invest the proceeds of your sale and build your retirement fund.

For those who plan to continue working after downsizing, deducting the mortgage interest you pay will help to shelter some of your income from taxes. Thinking of renting? Keep in mind that while monthly mortgage payments stay relatively the same, rent payments tend to increase.

Trading down isn’t always easy since it’s an emotional decision as well as a financial one. Give yourself some time to think about it, and consult with a CPA for advice concerning the financial and tax implications of your decision.

PUBLIC SERVICE ANNOUNCEMENT
HOME SELLERS: DON’T OVERLOOK THIS IMPORTANT TAX BREAK
Approximate Length: 45 seconds

If you are concerned that taxes may cut into any gains you make from selling your primary residence, the New York State Society of CPAs says you may be worrying needlessly. That’s because you are entitled to an exclusion of up to $250,000 – or $500,000 if you file jointly - on the gain from the sale of your primary residence. What’s more, even if you have claimed this exclusion in the past, you may claim it again. However, to qualify for this exclusion, you must have occupied and owned the residence for at least two of the five years prior to the date of the sale. If your gain exceeds the $250,000 or $500,000 exclusion, amounts over these thresholds will be taxed as a long-term capital gain. For most homeowners, that tax rate is 15 percent. So, if you are thinking of selling and saving your gain for retirement or some other purpose, don’t let the fear of taxes hold you back. If you have more questions regarding the tax impact of selling your home, contact a CPA.