How To Avoid Capital Gains Tax When Selling Real Estate (2018)
Hi, guys this is Toby Mathis from Anderson business advisors and today, we're gonna talk about nothing but. Selling, your, house. And when I say your house I mean something that you've lived in in the, last two. Years as a personal. Residence works, in the last five years but, you had two of the five years, as your personal residence so we're really looking at is something. That, you have lived in as your, primary. Personal. Residence not a vacation house, or anything like that something, that you actually lived in as, your primary residence and we'll. Go ahead and go over the tests because there are some exceptions, but we're just going to start from the. Basis. That you need to have lived in it 24. Of the previous, 60 months before you've sold it and. Then we'll go over what all the exceptions are excetera off of that so first thing, to know all. Assets. That you own whether. It's a car your. House, anything. Like that is, considered, a capital asset and. When you sell it if it's gone up in value or, if. You wrote it up it completely. And it's gone up in value you're, gonna have some, amount, of taxable, gain so if you bought your house and. We'll talk about how to do the calculations. But if you bought a house, and. It's gone up in value you're gonna have some. Sort of capital gain if, you lose value, if you, used it for personal use you, don't get to write it off that's, why if you buy a house and it tanks, you, sell it you don't get any benefit if you buy a rental property and it tanks you get to take the benefit if, you buy a house convert, it to a rental property then, it tanks you, get to write it off if you buy, a house, living, in his private, residence and tanks and then you convert it to a rental. Then you sell it not, the, same thing there's all little variations, but I hope you guys get to gist. Capital. Gains is what we're talking about when you sell an asset, for. Homes. There's. An exclusion to. The capital, gains it's found in Internal Revenue Code 1:21. That's, why they call it a 1:21, exclusion, and this, is the part, of the code that says if, you've lived and, you meet a certain test if. You own the home. And you, lived in it as your primary personal. Residence, for, two of the preceding, five years you have a capital gains exclusion. As. An, individual, up, to, $250,000. As a, married, couple filing, jointly, up, to, $500,000. So. In English I buy a house for a hundred thousand, my spouse and. Own. It for ten years lived in it always as my personal residence, and I sell it for six, hundred thousand, I'm, gonna pay zero capital gains because, when, you look at the look-back period this 5-year period did you live in it two of the last two. Years of the last five, yes. Was. It your primary residence during, that period yes. Great. Then we have this. Experience. Of non-qualified use in other words did you rent, it out in any period of time No, then we don't have to worry about it great hunter, percent exclusion, that, one that $500,000. Of gain is. Excluded. You don't have to report the game you pay zero capital, gains tax that's why it's so powerful all. Right so first off I'm.
Gonna Contrast, this this. 121, exclusion, which is for the house, that you lived. In, keep. In mind primary, residence two of the last five years it's, not the last two, years it's. Two of the last five so in theory I could. Have lived in it for a, number of years and then. Rented, it for five years and I would still get my 121, exclusion, its capital, gains exclusion, if I rented it for three years there's, a good chance that I would have depreciation. That is, not part of the equation I do not get to avoid depreciation. For. You guys that had home offices, that. Way you did the home office deduction, as a sole proprietor, that's, also, considered depreciation. You also get to recapture that so, there's, some little points. In here that. That. Can make it complicated which is why it's so important, that you listen to these types of video because there's lots of little pieces to it and, you're gonna see the exceptions. And the the variations. Can get maddening, at but, what we're looking at is in, the last five. Years that I owned it did. I meet the use, test, in fact I actually use a step, by step so I say step, number one will be like hey what. Do I get like what will automatically. Disqualify. Me like what things would, make it to where I do not get to use one twenty one number. One if your next pet, you. Don't get to in fact what do they say you're subject to expatriation. Tax, you're, done you don't get to take the 121 exclusion, how about a 1031, exchange - property, now I've lived in it but, I have not lived in it for at least five years or. Let's, see yeah, that. You acquired, the property in exchange - in the last five years you're. Done you do not get to take this it's, longer than that you can actually still qualify. And. Then if you don't meet, the, use. The. The, use and ownership. Test. Then. You, do not get to take the 121 exclusion, now, to that last, test. The use and ownership there. Are some exclusions, for partial use or. There are some periods of time or where we can actually defer, which. Is when you are active military Peace, Corps things like that and you get deployed.
And, We'll go over that but. The first thing is to look at this and say first off do. I fall into one of these exclusions, if. I do not follow, into one of the exclusions, then I can start looking in and, I'm going to be subbed I'm going to be able to work. Underneath the statute, the 121, and I might be able to exclude then, we look at the limitations. It's. Not a hundred percent of the gain it's, not a percentage, it's a dollar, amount and so if you're single the, dollar amount of capital gains you can exclude is two hundred fifty thousand if, you are married, filing jointly, the, exclusion. Is five, hundred thousand but. Both. Spouses, must, meet the use and ownership, test this, is where it gets funky. What. If you get a divorce, and you give the house under, a decree to, your spouse. Guess. What, you no longer meet the use test, if you're the one who got rid of it the person who. Is selling, could, actually use your use. And ownership, as part of their time I mean your use because they're the owner now so let's say that I get divorced my spouse spouse. Takes, the property, spouse. Sells the property they, can use the. The group, of us even just mine if I'm the if I'm the divorced spouse they. Can use my. Use. But. Since the ownership is in that service just, in the spouse that cut the, the. Property, if it's in their name underneath the decree and they transfer, that that, property into their name they're, the only one who can have ownership so you as, the, person who divorce it's, not your exclusion, it's, their exclusion but they can use both they. Can use both to qualify now if it's just them what, do we have we have a. $250,000. Exclusion, if you guys are trying to do it for yourselves then, when you divorce you better make sure you're both listed on that property and, they're gonna calculate, up, that you still have to meet the, use and ownership test you're both owners now, you both have to you have to meet that use test so you're gonna add you both up which. Can be a very yes that could be a boon or it could be a like. A horriffic, mistake, if, the lawyer doesn't catch it and you guys transfer, title, to somebody there's a few others which we'll go over but, we look at it we say are you the owner or owner and what they look at is if, you owned the, home for. At least 24, months two, years out of the last five, years leading, up to the data sale you, meet the ownership. Requirement. For. Married couple if you're still married only, one spouse has to meet the test for. Ownership. You. Still both have to meet for. Use and that's. The next step is if we look at it and say what is it used it has to be your primary residence so. Here's what it gets funny if. You did then. In the 24 months can fall anywhere within that five years. Then. It has to be your primary, personal. Residence so some people have two personal, residence it, has to be the primary and they actually do some tests and so they're, always going to look and say where. Did you actually stay. Now. There are some exceptions if you can't, take care of yourself and things like but we're, not gonna get that into, that that's for somebody, who has to you know who needs assistance and actually has to be removed from the home for for, four reasons which we'll get into but let's, just say for general. Purposes. You, must own it and have, used it as a personal, residence you. Have to own it at the time that you're selling it you have to have used it as a personal residence in 24. Of, the two. Years of the previous, five, then. We look back and we say are there any exceptions to, that eligibility and, that's, where we have some exceptions so and so let's. Take a look at separation, or divorce why. During the ownership of the home and then we take a look like that's going to be exception, for, the use not, the ownership so, again if you no longer own the house and it, sells it's not your exclusion, it's it's, the spouse that owns it if, you both still own it you're both still on title, then we can add it up and you guys can actually both, get your exclusion. Death. Of this spouse now. You have and then you have a period you have a two-year window of where you would sell it and they would treat it as though. You. Would you would be able to take advantage of both spouses as owners. Vacant. Land would. Be carved, out. Potentially. If it was used as part of your residence, so like if you had a big yard and you sold part of the yard then. It may be part, of your. Exclusion. You might be able to get a portion of it and. I. Mean, finally, there's some other exceptions, but we won't get into those right now I just, wanted to touch, on each one of those if, you. Are spouses, and, you. Don't, make. Up and you don't meet the 24-month, test, and you're.
Looking Back at, the. Use. What. They would do is they would say we were going to treat you each of single individuals so the spouse that's that lived in it previously that still owns it and you're. Selling it so you know example I lived in a house I get, married we. Sell it a year after we get married and they would say oh you're, not completely toast, you're not completely excluded, you, would just treat you each as single. People and so, my use in ownership I might meet it so I might get a 250. And dollar exclusion, even though we're married filing jointly, I don't. Get the full 500 but, at least I get the two hundred or the, 250 and let's, say that it's jumped up in value and I, meet. One, of the exclusions. To, that eligibility test, the exclusion, like we had to move for work or for health or and I'll go over what those are then, I may even then even my spouse even though let's, just say she did not live in it for, two of the last five years, she. Would fall under one of the exceptions. For, a partial, exclusion, then when you get hers as well so, there's. Always little nuances, like I said this stuff can get maddening if anybody ever says oh it's just straightforward easy it, is not I assure, you so, then we look at the the limits, and. So we look, and say do you meet the use, and. Ownership test, and, then let's take a look at see are there any periods, of disqualified. Use and here's what I'm talking about, disqualified. Use kind of goes like this, I'm. A landlord I own. My rental property, and then some smart. Lawyer says hey make it your house and, if. You sell it you have this big exclusion. Okay. I have, a period, of disqualified. Use, so. Let's say that I I had. It a rental for ten years and then I lived in it for two and then I sold it I would. Have a large, portion, of the. Gain. Disqualified. The, ten compared, to the - that's. The proportionality, and they would say hey you're gonna get a to twelve. Portion. Of the exclusion, because.
You Lived in it when we add up all the days and they actually go by days not by months you go by days and, you say what portion, of it was the. Residents, and what portion of it was used for business, so. There's, a big portion that could be disqualified. We call that disqualified, use that's, going to give you a partial, exclusion, the other, portion. Is like, things that will automatically. Exclude. You is you're, only allowed to take the 121, exclusion. Once. Every two years so. I can't, have a house that I lived in for, two years as. My primary residence, buy, another one live, in that two years and then. Sell them both in the same here and, expect my exclusion, I get to take one, exclusion. Every, two years what. I would have to do is sell, one of the houses make. Sure that I'm still qualifying. For. The other one and then wait two years and sell another which, people that do that and they use the exclusion, every two years, if. You, say if if you try to sell one within two years it's just an automatic denial, that's, just an automatic exclusion, the. Other exclusion. As we talked about was if you 1031, exchange, within five years just done. You, bought you 1031, when your rental properties, and then you moved in it for two years and then, you sell it you 1031. Within five years done. You don't get to use the 121, exclusion, you're just done and then the other the. Other way is just to fail the use and ownership test in which case though there we have some exceptions. What we call partial exclusions, that we could use so, so it's, kind of step number one going, all the way back to the beginning is you determine, whether there's things that automatically, keep you from qualifying, assuming. That you're not an expat, that, he didn't just 1031, exchange it that. The. You. Haven't, done an exchange within the last 24 months then. We're. Gonna take to step number two which is to look at the use and ownership test, and. We're gonna go through that we're going to determine, whether there's a period of disqualified. Use and, we're gonna calculate all this fun stuff remember, this is only for capital, gains so. There, might be some. Depreciation. That, gets to be recaptured and when, you do the worksheet, when you actually look at what the IRS requests, when you actually do the calculations. You're. Gonna see that that gets excluded, from gain and I'll go, over how you actually do the calculation here, in a second and that. Portion is going to be subject, to dividend recapture, so again going back to the example of I owned, it as a rental for ten years than I lived in it for two than I sold it there's, ten years of depreciation that's. Not part of the game that's actually comes off the top and that's subject to depreciation. Recapture. Which, would be a twenty five percent right now that's, that, would be subject to that taxation, I can I can exclude, a portion. Of the gain like I don't just lose it I would get to 12th under that exam of the.
Gain, Excluded. So. There's always these kind of exceptions, the other area, of exception. Is if. I was forced to move so let's say that I owned, it and. I sold it but, I didn't, meet the use test then. There are a few. Exceptions. And this. Is when we look and state do I get a partial exclusion, and here's, the partial, exclusions. So. This. Scenario, is I lived in the house I. Lived, in it for a year, as, my primary. Residence and then I had to sell the house because I was forced to move for. Work and, if you worked then it's gonna be at, least 50. Miles, farther. Than. The old location. 50m, are 50, miles, farther, from your home, so, it's not there's 50 miles away it's, 50 miles farther. Away, than. Your old location, and. So. Let's say that you had, a house and you. Commuted, 15. Miles to, work the. New house needs to be at least 65. Miles away hope that makes sense and, then I can get a preview I can get a partial exclusion, so if I'd be entitled. To a $250,000. Exclusion, if, I had lived in it for 24 months but I only lived in it for 12 then I would get a. $125,000. Exclusion, I would get half of the exclusion, because I lived in it half of the time that's the partial exclusion, a health. Related move will work also and, that's if you, had to do it to facilitate. A diagnosis. To cure. Some, you know some health issue or if. You had to care for family members and the family members can be a child grandparents. They actually have a list brother sister mother-in-law, on. To uncle nephew niece all these things could. Could be included and then they have some catch all's they say unforce, evil events, and, so unforeseeable, events. Can be the death of a spouse. Could. Be divorce. Or separation, those, things what, might allow you so if you so you buy a house and then your, spouse pops on you that they want to get divorced and you sell it a year after you guys moving it you, didn't meet the 24, months, but, you have you, have you have ownership, you guys you know both on ownership but, then the use wasn't, you'd get a partial exclusion. If that was the cause for the move, if. You have twins or more in twins triplets quadruplets. Quintuplets. Sex, - you know I give you just keep going if you had more than one child, unexpectedly. Then that. Just going to give you grounds also for a partial exclusion. And. Then if you if, you lost a job or something like that that could also give you a partial exclusion. Other. Facts and circumstances. They. Would look at basically. This is where you throw the kitchen sink at I'm saying hey we didn't anticipate something, occurring. And this is the reason that we had to move and you can you try your best on that one to get a partial exclusion, I've never I've, never seen too many of those come, along but. They. Do happen now here's another little thing there's. A few points of clarity if you've. Been using your house at all as a. Personal, residence after, you've been renting it or if you rent it too after, you use it as a as a personal. After. The personal use because they're treated very differently so. First off we'll go to the first, thing. We were talking about which is the disqualified, use if, you'd use it as a rental and. You had a rental property then you moved into it the, period of the rental, is disqualified, used as we talked about however. If. You use, it as your personal. Residence. Your primary personal residence for two years and then, rent it after that and then sell it as long as that sale is within, three years so you still meet the two out of five that. Portion doesn't count we don't we don't we don't count that put. Another way if I have lived in a house for, twenty years and then, I decide, I'm going to rent, it out and I rent it out for less than three years the. Way the rules written is they don't count that as disqualified. You so long as the the date that you sell, two. Of those last. Five, years you use it as your primary residence they don't count that portion, as disqualified, use so. In one case somebody. Has it as a rental they. Move into it, and. They use it for their. Personal, residence for two years than they sell there'd. Be a period of disqualified, use. Would mean, they'd lose a substantial, portion of the exclusion. So let's just use round, numbers I rented. It for two years lived in it for two years sold, it so I owned it for four years total I would, get half of the exclusion, that I'm entitled to so a married couple, married. Filing jointly, they'd have a $250,000. Exclusion, a single. Person would have a $125,000. Exclusion, you just cut the numbers in half. There's. Another portion. Of that of course which is the depreciation if, they depreciated that property, that's, not part of the game that's not part of the exclusion, that's, depreciation. Recapture, it's actually a 25%, so, you'd, end up having to do, that calculation if, let's flip it around I lived.
In It for two years then. Rented it for two years and sold it I only owned it for four years I get a hundred percent, of the exclusion, because we don't count those those. Years, after, I lived in it that's, my primary residence so, the, one the, reason that rules there is to prevent landlords, from, just going in and moving, into their houses, for. Two years and selling and every two years just selling one of their properties that may have substantial. Appreciation. They just want to they. Don't want anybody to be gaming the system in that way now, where. You are where it's fully allowed and the IRS actually have their as the calculation. Written out on its website is when. You have. Appreciation. That's. Far in excess of what you're allowed to take so, for example, in let's, say you're in San Jose or San Francisco area, where you've had this big huge run-up and you bought a house for $500,000. 10, years ago and now it's worth 2.5 million. So, if you were to sell it you'd have two million dollars of gain. And you might be able to exclude five. Hundred thousand of it if you're married filing jointly, if you're following me so you meet, the the use and ownership test you get the full exclusion, but it's not enough it's, a half a million dollars that's just going to put just, a little dent so you paid half a million you have two million dollars in gains so you're gonna get you're. Gonna get exclude, five. Hundred thousand of that you're still gonna pay a big chunk of tax, if you want to avoid all the game here's, how you do it and they spell it out you, would take the house that, you lived in as your person and, you'd converted into a rental and I would suggest that you rent it for at least a year there's. Not a hard and fast rule on that you just have to make it into a rental property an investment, property once, it's an investment property it. Can qualify under 1031, exchange so. You're, allowed to go out and buy other investment, properties with it now that doesn't mean you can go out and buy another house you're going to live in but you could buy investment, properties, and after a while make those into your personal residence again. You work with a tax advisor on this but you could exclude, the. Hunt the 1.5 million dollars in game so, I could actually take, a house I've lived in it for five let's say lived in for five years it's a highly appreciated, half a million dollars again I'm all going to get to write off out of it and I want to avoid the gain on the other half I could, convert, that into a rental property rent, it to somebody and.
What. Am I going to do in the meantime you could do the girl rent a house you know to buy another house because. You're allowed to use the 121, exclusion, every two years but. You don't have to live in it the day that you sell. It it doesn't have to be your primary personal, residence the day you sell it you just have to have met the use and. Ownership. Requirements. Of two out of five years prior. To sales so then you would sell that and say a year later and, you. Would be, able to 1031, exchange it into other properties. And. Then those other properties, after, you buy, them. Technically. You could actually go and move into those at some point make them into a your, primary residence although, you, probably say let's just keep them as rental. Properties let's go buy a bunch of rental properties and go buy another house, that. You could live in or rent another house if you want to live in it or just you know if you're in this situation chances. Are you have the means to go out and buy another home and you wouldn't have to worry about it but, you can avoid the, gain entirely. If you, want, to so it is a possibility, last. Thing is. How you actually calculate gain. And. So as you've heard me say, depreciation. Is not included, in the capital, gains exclusion, so the way the IRS has you do the test is they say what, is your basis, you got to calculate up your basis and I'll go over that in a second you take the gain and, you subtract the basis off the game that gives you a number I, mean, the total sale minus. The basis is going to give you your your. Your gain kind, of the first level of gain they, write down this number then, you exclude, from that gain any depreciation recapture. That comes from having, done, your house as a home office or having. Taken, depreciation. If it was an investment property so. If you have any of those numbers let's say you had, $500,000. Of gain but. You had $25,000. Of depreciation recapture, you, no longer have $500,000. Again for purposes, of this section you, have four hundred and seventy-five, thousand dollars again, and then you'd actually, take that twenty five thousand dollars of depreciation recapture, and recognize. It on your schedule D so. There's. A portion of it that would be excluded from from tax and then you'd have a twenty five percent tax, on that on that depreciation recaptured. The, way you calculate all these things and the, most important numbers are what are you selling it for it. Doesn't have to just be cash it could be other properties, that you're getting exchanged other services that you figure, out what's, the actual, sale price. 99.9. Percent of the time it's just gonna be cash it's gonna be you, know I'm selling it for US currency and, it's easy to calculate, make. Life world you know the, your, world more difficult is to try to add Bitcoin I don't know any escrow companies that really want to deal with that right now, but. You know whatever you do whatever you exchange whatever the value is is what. Your sale price is and then from, that you remove the basis and bases is what you purchase. The property for plus, we get to add things into it and like that add it into it is your, fees and closing, costs for example abstract thieves, utility. Services, that you had to pay recording, fees survey fees transfer. You. May have paid these when you bought the property but, they get added into your basis you never got to you never get to write them off construction. You would at you would add in the cost of labor materials in any construction, that you did. Even. If you had to pay real estate taxes. Up.
Through The date that of the sale date. If. You were paying it for some something that you paid to the seller for example, hey I'm gonna pay off some of the taxes, you didn't, get to write that off because you didn't own it so. You would, just add it into your basis, bank, or back interest, even. Recording, fees if you agreed to pay some of the closing car and even, if you paid some of the sales commissions, okay I really want this house and they shifted them over to you that gets added into your basis don't forget to calculate, that, big. Things that are examples, of improvements, that we see some people miss and I'm gonna go through a whole bunch just. To make sure that you're filling your head in with what things get added into basis because this comes, right off the game this is something immediately right off so it's like makes. Life easy if, we have zero net gain then, we, don't have to worry about anything right additions, are there anything that you added is the bedroom bathroom, deck. Gosh. Porcha. Patio any of that stuff gets added into your basis, your. Lawns and grounds your landscaping, if you added a driveway walkways. Defenses. Retaining, walls swimming pool any of that gets added into your basis. Systems. Like your heating systems air conditioning, furnace. Ductwork. Central, humidifier, air, filtration. Water. Filtration, wiring. Security. System, even. If you put in a sprinkler, system for, your lawns all that, stuff goes in plumbing. Is your septic system your, water heater, soft. Water if you live in like, I do in Las Vegas everybody has a soft water system all that gets added into your basis, interior. If you have built-in appliances those, got added into your basis, kitchen. Modernization. If you upgrade your system you know your the doors, on all your cabinets, that type of thing flooring. Wall-to-wall carpeting, all that stuff comes in fireplaces. Even. If you put in insulation. Into your attic or into your garage some people are doing that now underneath. The floors pipes all that stuff if you're in all, that gets added, big. Things that you might do outside satellite, dish new siding even. Putting on a new roof all, that, gets added in to your basis, and. So when you're calculating out, what, gain you have you, got to know what's the sale a price. -. What the basis is and that's going to give you your, primary, number if you didn't know if you never rented, out your house or, if, you never used a home office or even if you did you did not take the deduction I wish. You didn't do it on your schedule see during the period of time when we had the. They considered that a dividend, which isn't anymore but. If you did in the past five, years or so you may, have some dividend recapture. And. This does not include. Reimbursements. That you took like if an, employer reimburse, you for the use of your house that doesn't get reported anywhere that's not depreciation. Recaptures but. If you if you did not have any of that or if you did rent your house out but you did you, took zero depreciation. That you don't have to worry about it you just use the capital gains exclusion. That. You have under 121, I hope, that this helps and, I hope that you realize that anybody who says Oh 121. Exclusion this is what it is it's, not there. Are lots of little exceptions, we didn't mean like there there's some crazy ones that are out that I don't want to bend your head on but, if you're a member of the service and things like that we can actually have periods of deferment. That are up to 15 years. That. That we can extract the tests on even if you're deployed for 10 years we can still go back and capture this so. The. Point of this is just to know that 121, is a boon, if, you're selling a house you don't want to pay, capital. Gains if. You have too much appreciation. You can actually couple this. With your 1031, exchange you actually do the, 121, exclusion, plus the 1031, exchange, way, it works is the 121 exclusion, gets added into basis, so, if you have the the, 2.5.
Million Dollar house that you bought for 500,000. The new basis, and the new properties, is a million you get to use the 121, exclusion, the 500,000. Hit a million you, get to if you're rolling it in other investment, properties you exclude the the, 1.5, million dollars gain it's an amazing. Amazing tool. But. There's a lot of different nuances, to this that makes it something that you really should have somebody run the numbers with before, you doing it but I hope that helps Toby, Mathis with Anderson business advisors.