Real Estate Is A Good Thing!
Don't forget the tax benefits and consequences
of buying, selling and owning real estate. The following discussion is presented
for information purposes only, and is not intended to be advice. To get the
most out of any discussion, your own personal tax situation should be taken
into consideration. Please consult your tax advisor or attorney for the latest
tax code and how it affects you.
Benefits
of owning your own home
Sale of Principal Residence (effective 5/7/97)
IRA Distributions for first-time homebuyers
Rental Property
Capital Gains/Losses - Sales of rental property
IRC 1031 Like-Kind Exchange (Starker Exchange)
This information has been provided as of September
24, 1998 courtesy of Joy Ellis, CPA of Ruga & Ellis, CPA's of Annandale,
Virginia. Mrs. Ellis is a 1980 graduate of James Madison University with 18
years experience in public accounting. If you are new to the area or interested
in establishing a relationship with a CPA, please call to set up an appointment
with Joy at (703) 941-5400.
Benefits
of Owning Your Home
There are many intrinsic benefits to owning your
own home, with which most people are familiar. In addition, the tax benefit
of an itemized deduction for qualified mortgage interest and real estate taxes
may give another advantage over renting. Calculate your savings over renting
by figuring your excess of itemized deductions over the standard deduction
amount (which you are already allowed). Multiply this number by number by
your federal and state tax bracket percentage. This is you yearly tax savings;
divide by 12 to get your monthly savings. Subtract this savings from your
monthly payment to get your "net monthly housing cost." Compare
this to the rent you are presently paying. You will also have to measure utilities,
etc., on a case by case basis. Remember, itemized deduction limits apply when
adjusted gross income reaches $124,500
($62,250 for MFS).
You can adjust your W-4 for additional exemptions,
so you can receive these savings each pay period.
Sale
of Principal Residence
Effective 7 May 1997, you may exclude up to $500,000
on a joint return, $250,000 for single taxpayers, of gain on the sale of a
principal residence. To qualify you must have:
There are no longer requirements for subsequent
home purchases or benefits for taxpayers over 55 years of age. This exclusion
may be taken every 2 years. If you do not meet the requirements above, regular
capital gain rules apply.
IRA
Distributions for First Time Homebuyers
For distributions made after December 31, 1997,
the 10 % penalty will not be charged if the individual uses the IRA money
for certain expenses associated with buying a principal residence. Regular
taxes will still apply. Only $10,000 during the individual's lifetime may
be withdrawn for this purpose without a penalty. Qualified expenses include
acquisition costs, settlement charges and closing costs. The principal residence
may be for the individual or the individual's spouse, child, grandchild or
ancestor of the individual or the individual's spouse. In order to be considered
a "first-time homebuyer", the individual (and spouse, if married)
must have not had an ownership interest in a principal residence during the
two-year period ending on the date that the new home is acquired (Code Sec.
72 (t) (2) (F).
Rental
Property
Generally, you must include in your gross income
all amounts you receive as rent. You can generally deduct the ordinary and
necessary expenses for managing, conserving and maintaining the property in
the year you pay them. The cost of improvements must be separated and may,
along with the non-land portion of the property, be depreciated over 27 ½
years per an IRS provided table.
Specific rules apply to partial use rental property
such as vacation homes.
All rental activities are considered passive activities
and are therefore subject to passive activity rules. Exceptions to passive
loss limitations apply to taxpayers with modified AGI under $150,000.
Sale
of Rental Property
When you sell rental property, you must report
the gain on the sale on your tax return. The gain is the amount realized (everything
you receive) less selling expenses, as compared to your adjusted basis. For
sales beginning in '98 on property held over 12 months, gain is taxed at 20%
(or 10% depending on income level) and depreciation is recaptured at 25%.
Losses are deductible in full as ordinary losses.
Tax
Deferred Exchanges
Internal Revenue Code Section 1031 Like-Kind Exchange,
also known as Starker Exchange, provides a tool for the tax-free exchange
of one investment property for another. Because of the complexity of these
transactions and all the rules (plus exceptions to the rules) you should not
attempt this exchange without the help and guidance of an attorney and/or
CPA that is well-versed in tax deferred exchanges. The tax consequences can
be devastating if the transaction is not done properly and the IRS disallows
the exchange.
Some key points to keep in mind when contemplating
a 1031 Exchange follow. To be non-taxable, a trade must meet all six of the
following conditions.
-
The property must be business or investment property. You
must hold both the property you trade and the property you receive for business
or investment purposes. Neither property may be property used for person
purposes, such as your home or family car.
-
The property must not be property held primarily for sale.
The property you trade and the property you receive must not be property
you sell to customers, such as merchandise. It must be property held for
the productive use in your trade or business or property held for investment.
-
There must be an exchange of like property. The exchange
of real estate for real estate and the exchange of personal property for
similar personal property are exchanges of like property. The trade of an
apartment house for a store building, or a panel truck for a pick-up truck
is a like-kind exchange. The exchange of a piece of machinery for a store
building is not a like-kind exchange. Real property located in the United
States and real property located outside the United States are not like
property. In the case of transfers after June 8, 1997, personal property
used predominantly within the United States and personal property used predominantly
outside the United States are not like property.
-
The property must not be stocks, bonds, notes, choices in
action, certificates of trust or beneficial interests, or other securities
or evidences of indebtedness or interest, including partnership interests.
-
The property to be received must be identified within 45
days after the date of transfer of the property given up in the exchange
(in writing).
-
The property to be received must be received by the earlier
of:
-
The 180th day after the date on which you transfer
the property given up in the trade, or...
-
The due date, including extensions, for your tax return
for the year in which
the transfer of the property given up occurs.
If you trade property with a related party in a
like-kind exchange, a special rule may apply.
The relinquished property must be marketed as part
of an exchange. You can exchange the relinquished property for up to three
other properties, or a property worth up to 200% more than the relinquished
property.
Depreciation taken on the relinquished property
will be recaptured to determine the basis of the relinquished property. The
basis of the relinquished property will transfer to the replacement property
before adjustments for boot received and/or mortgages assumed or placed on
the property.
