Some Tax Reminders for Home-Owner Clients

Jun 25th 2018
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When talking with home sellers, I’ve long ceased being surprised by how many routinely overlook or fail to take maximum advantage of a valuable tax break: the exclusion when unloading their principal residence.

The law caps the exclusion—meaning you pay no taxes—at $500,000 for married couples filing jointly. The exclusion drops to $250,000 for singles and married couples filing separate returns.

I frequently need to remind sellers that these exclusions apply to profits, not sales prices. In other words, it’s the amount over and above their home’s cost basis—the figure used to determine gain or loss on a sale of the property.

Cost basis includes not only the original purchase price, but also any home improvements and many costs incurred when buying and selling. Understandably, sellers want to know what they’re likely to shell out for taxes when their profits exceed the applicable exclusion amounts. I tell them that there’s good news and bad news:

  • The good news: For most sellers, the excess is taxed as a long-term capital gain, and the maximum rate is usually 15 percent plus applicable state taxes.
  • The bad news: For lots of high-income sellers, the maximum rate increases to 20 percent. What’s worse is that it goes as high as 23.8 percent for those who are subject to the Medicare surtax of as much as 3.8 percent on income from certain kinds of investments, including profits from home sales. The surtax was introduced in 2013 by the Affordable Care Act, popularly known as Obamacare. 

Note that lower rates for income taxes were the center piece of the Tax Cuts and Jobs Act (TCJA) that was enacted in December of 2017. But the Act didn’t authorize lower rates for other kinds of taxes.

The TCJA left unchanged the rates of 15 percent and 20 percent for capital gains and 3.8 percent for the surtax. Those rates remain on the books, at least for now, unless Congress changes the rules again.

In previous columns, I’ve noted that home owners are no longer entitled to a 100 percent write-off for state and local income taxes and property taxes when they itemize deductions on Form 1040’s Schedule A. The ceilings are $10,000 for couples filing jointly and single persons and $5,000 for married persons filing separate returns.

Those limitations aren’t indexed to reflect inflation. They particularly hurt home owners and high-income individuals who live in states like California, Connecticut, Massachusetts, New Jersey and New York, and the District of Columbia.

The TCJA-mandated restrictions apply starting with returns for calendar year 2018 that are filed in 2019. They end after 2025.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 250 and counting). 

Replies (2)

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By Lydia L Banes
Jun 25th 2018 19:58 EDT

This is a question, not a reply. Is the exclusion of $250M and $500M only apply when the homeowner buys a replacement home?

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Replying to Lydia L Banes:
By trbrock
Aug 15th 2018 13:57 EDT

No the homeowner does not need to buy a replacement home for the exclusion. The Sec 121 exclusion is available for the sale of a principal residence that the homeowner has lived in for the last 2 out of 5 years. Vacation and 2nd homes would not qualify.

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