IRS Provides Relief

The American Jobs Creation Act of 2004 included numerous provisions designed to curtail corporate tax shelters. Among them is a provision that imposes restrictions resembling the passive-loss rules on partnerships that include both corporate and tax-exempt partners. These newly-enacted tax shelter limitations could reach real estate partnerships or tiered arrangements that include tax-exempt partners such as pension plans or certain insurance company arrangements. The IRS has noted that partnerships that include these large tax-exempt entities are not necessarily tax shelters. Accordingly, the IRS has issued IRS Notice 2005-29 providing that the rules enacted in 2004 will not be applied to partnerships in tax years beginning before Jan. 1, 2005. In practical terms, this means the U.S. Treasury and U.S. Congress will have until April 2006 to sort out the correct rule for real estate partnerships that include tax-exempt entities.

It has been nearly eight years since the law changed, but many homeowners still don't know that the old rules about having to "roll over" profits from the sale of a home into another home purchase to avoid capital gains taxes are history. Enacted in 1997, the not-so-new rule is that if you sell your main home and have lived in it for two of the past five years, the first $250,000 of any profit you make is tax-exempt if you're single, and the first $500,000 is exempt if you're married. Any profits above those amounts face a 15 percent capital gains tax, except for taxpayers in the 10 or 15 percent income tax brackets. For them the capital gains tax is usually 5 percent. Since the rule change, confusion has spread about when homeowners can get the tax break even if they have lived in their homes less than two years. If the reason for the sale of the home was because of a change in employment, a health reason or a list of defined "unforeseen circumstances," you can still qualify for a partial exemption of the profit you made on your sale. There's also an exception for homeowners in the military or foreign service who have been on "qualified official extended duty." But there are a couple of exceptions that won't work, the IRS said in 2004: Moving because road noise is worse than you expected, or moving to Florida because year-round golfing might be good for your health, for example. To figure out how much profit you made when you sold your home (or "gain" you had, in the language of IRS Publication 523, "Selling Your Home"), you take the selling price and subtract your expenses, such as commissions or legal fees. This gives you the "amount realized" on the sale. Then you subtract the "adjusted basis value" of your home from the amount realized, and now you have calculated your gain or loss for tax purposes. The adjusted basis value typically includes what you paid for the home, plus many of the costs of buying it -- such as escrow fees -- and the costs of any qualifying improvements you made to the home, and any closing costs you paid if you refinanced your mortgage. To document the expenses, be sure to keep records of the improvements you make to your home. Consult IRS Publication 530 ("Tax Information for First-Time Homeowners") to see which improvements will increase your home's basis value.

Posted by Donald Urschalitz P.A. at June 2, 2005 08:51 AM