Impact on Taxation and Finance April 01, 2007

Rolling Over Capital Gains

BY EDGAR HENRY

Did you know that if you sell your main home for a large profit, you may owe capital gains taxes? However, you can exclude up to $250,000 in capital gains from your taxable income, provided you meet the IRS’s ownership and use tests.

Ownership and Use test

Ownership test is a requirement by the IRS that you must own a home for at least two years in order to exclude from taxable income the allowable amount of capital gains earned on the sale of your home. This two-year period must occur during the five-year period that ended on the date you sold the home. By the same token a use test is a requirement by the IRS that you must have lived in a home as your main home for at least two years in order to exclude from taxable income the allowable amount of capital gains earned on the sale of your home. This two-year period must occur during the five-year period that ended on the date you sold the home.

Capital gains tax

Capital gains tax is defined as the tax levied on profits from the sale of capital assets. The capital gains tax rate is lower than the tax rate on your ordinary income. To qualify for the capital gains tax rate, you need to hold a capital asset, such as an investment or home for more than one year. That means 366 or more days. Gains on capital assets held for more than one year are called long-term capital gains. Gains on capital assets held for one year or less are called short-term capital gains. Short-term capital gains are taxed at the same rate as ordinary income.

The average long-term capital gains tax rate for most taxpayers is 15-20%. The long-term is now also 15-20% for investments held for five years that have been purchased since Jan. 1, 2001. This means that this year 2007, while filing your 2006 return, the lower long-term rate will apply unless you use the deemed-sale method. However, if you are in the 10% or 15% income tax bracket, the long-term rate is 5%. If you are in either of the lower tax brackets and have owned a capital asset for at least five years, your long-term rate is also 5%.

If you're married and filing a joint return, you can exclude up to $500,000 in capital gains from your income, provided, either you or your spouse meets the IRS' ownership test. Both of you must meet the IRS' use test. Neither of you have excluded the capital gains from the sale of a home in the previous two years.

The amount of your capital gain is your amount realized which is the price you receive from the sale of a home or other capital asset minus expenses directly incurred from the sale. These include commissions and advertising, legal, or similar fees, minus your adjusted basis. Adjusted basis is the difference in basis of your home or other capital asset and any increases or decreases to the basis. For homes, increases to basis include improvements that have an expected life of more than one year, additions, special assessments for local improvements, or amounts spent after a casualty to restore the property. If your adjusted basis is larger than your amount realized, you have a capital loss.

Basis

Basis, or cost basis, is the price you pay to acquire an asset. It is used to calculate your capital gain or loss on an asset. Basis includes most related costs that are necessary to take full ownership of the asset. To calculate your adjusted basis, start with your basis. This is the cost of buying or building your home, and includes closing costs and settlement fees. Add any increases or decreases to basis to calculate your adjusted basis.

Deferring Capital Gains Tax

One of the reasons people choose to use a 1031 exchange is to defer paying capital gains tax on their business or investment real estate. Section 1031 of the Internal Revenue Code provides for the deferral of capital gains taxes with a tax-deferred exchange. A tax-deferred exchange or a like-kind exchange is a method by which a real property owner can sell his property and then reinvest the proceeds in ownership of like-kind property and defer the capital gains tax. The process gives the 1031 exchanger more buying power because the capital gains taxes are deferred. Capital gains taxes on the sale of the property are deferred until the like-kind property is sold at a future date.

Each buyer should review any investment or transaction with legal and/or tax counsel to determine the amount of capital gains they owe. To qualify as a like-kind exchange and avoid capital gains taxes, property exchanges must be done in accordance with the rules set forth in the tax code and in the treasury regulations. In order to defer all capital gains tax in a like-kind exchange, the real estate buyer should follow these guidelines:

The exchange proceeds must be reinvested in the acquired property and the acquired property must have the same or greater value.

Obtain equal or greater equity in the replacement property.

Obtain equal or greater debt in the replacement property or have a reduction in debt that is offset with additional cash at closing from the taxpayer.

Receive nothing except like-kind property.

Besides deferring capital gains tax, there are numerous other benefits of a 1031 exchange.

However, the information in this article is not intended to replace qualified legal and/or tax advice regarding capital gains taxes. They are merely statements and guidelines to equip readers so that they may be cognizant of capital gains information.

EDGAR HENRY

Is a Licensed Tax Preparer and can be reached at (718) 469-0183

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Impact on Real Estate and Business April 01, 2007

Things that can alter the value of your home

There are several features that can add value to your home, and others that could rapidly reduce the sale price. In this article, I will change gears and explain what is necessary to alter or change the value of your real estate investment in the eyes of potential purchasers.

An updated kitchen

Times have changed drastically as it relates to value. Ten years ago, nobody cared, today everybody wants them. The majority of persons looking to purchase homes, place particular emphasis on certain amenities. Women in particular feel that kitchens are critical, and they simply adore a big kitchen with a lot of workspace. They look for solid surface counters and high-quality flooring, such as wood, laminate, tile or stone. Even if the kitchen is not huge, it should have countertops that are serviceable and ones that aren't going to have to be replaced soon. Cabinetry in good condition has to be well-appointed and large enough to fit their needs. It doesn't hurt if it opens onto another room. Nowadays a lot of families are looking to have a window over the sink.

Modern bathrooms

Buyers are looking for master baths that give a little room to roam; a big asset would be a Jacuzzi or whirlpool tub. In my 20 years as a real estate broker, I am amused by people who have them in the master bath and don't ever use them, but guess what? It’s a big feature that attracts the eye and coincides with the asking price for leverage. Some other features buyers are seeking are separate showers with steam and/or multiple jets, double sink, and a separate room for the toilet. The seller has to make sure the plumbing and hot water heater can handle the job.

A well-appointed master suite

Some people have a passion and are really excited about master bedroom suites. The wish list is basically a luxurious bathroom and lounging areas, with his and hers walk-in closets. They love natural materials such as ceramic tile, hardwood floors, not much carpeting and granite. In floor coverings they look for ceramic tiles or parquet wood rather than linoleum, which can tear easily. In the rest of the house, wood or laminate products are a plus over wall-to-wall. But if you have carpet, it should be a good product and well maintained so that a person doesn't have to spend $5,000 off the bat to replace it.

Outside appearance

A good first appearance on a home can add as much as 5 to 10 percent to the value of the home. A light, airy spacious home is at times preferable. People normally buy space and light. However you will find the occasional person who walks into a really dark house and remark 'I love this.’ Most people are still looking at exposures and windows. It's been a cold winter for most of the country and energy efficiency is very important. Insulated windows are always a plus; typically, they pay for themselves in the long run. Beautiful landscaping and having outdoor spaces with touches such as pergolas and Victorian garden swings can be very helpful. Conversely, you don't have to spend a fortune on plants, either, just keep it typical and in tune with the neighborhood.

Lots of storage

Nothing beats an oversized garage, some attic space and plenty of closets. If you have a two-car garage, do you have extra space for those things we all have, such as bicycles, lawn mower and snow blower? Space is important. Unless you're living in a condo, retirement community, or in a town neighborhood, most buyers will look for at least a two-car garage. If you don't have a garage, it's a real negative, also if you have a one-car garage that could also be a problem. A finished basement adds even more value. If a basement is dry, it's a plus, but it's a negative if it has water problems.

Liabilities

On the flip side, here are a few things that could harm your home's value such as a swimming pool. Forget what you might have heard. An in-ground pool in most parts of the country doesn't automatically raise the value of your home. Having a pool will automatically limit your market when it comes time to sell. It's a constant upkeep. Generally they crack, the equipment goes down, it's expensive to replace, and the liability is high. Purchasers shy away from it especially if they have small children. Others consider it a mixed blessing. For the people who want the pool, they're willing to pay for it. But there are an awful lot of people who don't want a pool. You have to weigh the odds.

Who wants an electrical system or plumbing system incapable of handling modern conveniences? Would you buy a home if the appliances were worn or broken? Roofs are expensive to replace and a good roof is considered standard equipment in a house. If your roof has problems, expect to take a hit in the price. If you've got an old roof and outdated paint, I don't care if you've upgraded the kitchen, you won't even get the buyer out of the car. If you know you've got to have something fixed, fix it. Otherwise, people will subtract the cost or not make an offer on the house. And if people think the house hasn't been taken care of, they will wonder what else they're not seeing. Besides being a danger to human health, lead, mold or asbestos can kill home value from an environmental hazards point of view.

"It is always better to have information and not need it than to need it and not have it."