Capital Gains Tax for Home that Burned Down

[andys1027]

My townhouse/condo burned down on December 30, 2021 (Marshall Fire - Louisville, Colorado). A family member sent me money to buy a new home while the condo was being rebuilt using HOA insurance money. Almost 3 years later, it was rebuilt and I listed it and sold it within 2 months of getting the house keys (12-16-2024). I never moved into the condo after it was rebuilt and it has not been my primary residence since it burned down. As soon as the net sales was wired to my bank account by the title company, I wired the entire amount to the relative who had paid for my new primary residence a month after the fire. The title company already sent me the 1099-S for the Capital Gains. QUESTION: DO I STILL PAY CAPITAL GAINS? My annual income is just under $50k and I am 70 years old. I cannot find an available CPA to help me with this. I plan to use TURBOTAX to do my taxes as I have done for the past 20 years.

[Opus 17 · Accepted solution]

Yes, you are subject to capital gains tax, as on the sale of any property.  But, you qualify for the personal exclusion on the sale of your home.  See publication 523.

https://www.irs.gov/forms-pubs/about-publication-523

You can exclude the first $250,000 of capital gains from your income (or $500,000 if married filing jointly) as long as you owned the home at least 2 years, and lived in it as your main home for at least 2 years (731 days) over the 5 years prior to the sale.  Since you sold the home on 12/16/24, the lookback period goes back to 12/16/19.  As long as you lived in the home as your main home between 12/16/19 and 12/30/21, you can use the exclusion.  You don't have to worry about special rules for damaged or destroyed property, since you qualify for the normal exclusion.

If your gain is more than $250,000, you will owe capital gains tax on that amount of the gain.   It doesn't matter how you spent the funds after the sale.  

However, there is also an issue of how to determine what the gain actually was. Since this was a federally declared disaster, you were eligible to report the loss on your tax return.  You did not mention that, so I will assume you did not report a loss.  (And, if insurance paid for rebuilding, then you had no loss.)

Your gain is the difference between the selling price and the adjusted cost basis.   The adjusted cost basis in this case would be the price you paid for the home when you bought it, plus the cost of any improvements you made before the fire, minus the value of the insurance payout, plus the cost of rebuilding.  Assuming the insurance exactly paid for the rebuilding, those two items cancel each other out.  You can also include in your cost basis, certain closing costs from the purchase, and you can reduce the selling price by certain costs of selling (like real estate commission, advertising, staging, and any county or state taxes and fees that are not related to your mortgage -- taxes and fees you would have to pay even if there was no mortgage).  

In turbotax, you list your purchase price, adjustments like closing costs and improvements, and the selling price.   (Use the full selling price from the 1099-S, and include adjustments to the selling price like commission and advertising under adjustments to cost.) The first $250,000 is tax-free and the rest is subject to long term capital gains tax.  Then, because of your low annual income, even if the gain is more than $250,000, some of the remaining gain is likely to be taxed at zero percent, and the rest at 15%. 

[andys1027]

First: Thank you so much for your reply. I did NOT file this as a loss after the Marshall Fire. I don't know if that would have helped at the time (you mentioned something about 'exclusion'?) Anyway, the condo was purchased with a mortgage in April of 1985 for $67k. The mortgage was paid off in November of 2014. As I stated earlier, the condo burned down (along with 29 other condos) on December 30, 2021. The condo HOA used it's insurance claim to rebuild the 30 total loss condos that included the original finishing work inside (carpeting, appliances, etc.). The condo was finally certified for occupancy by the city on Oct. 16, 2024. (Since the fire, I have been living in a new what became my primary residence that was paid for by a relative, that is in my name). The condo was listed on Nov. 1st of 2024 for $425k and closed on December 16th. I received $385k (net sales after fees, commissions, closing costs, etc.) from the title company and immediately wired the entire amount to the relative who paid for my current residence. I spent about $5400 on adding blinds, ceiling fans, stage furniture, etc. before listing through a realtor. The only big upgrades done to the condo since it was built in 1985 was adding central AC (about $10k). All this was destroyed in the fire and it was discovered that the HOA insurance claim would cover the cost of replacing the AC (along with the furnace and hot water heater that came with the original condo, and NOT from my individual homeowner claim. My annual income is just under $49k after taxes. That's all I can tell you and I have no idea what other forms to file with my taxes next year that would help exclude or minimize whatever capital gains I might owe from this sale.

[Opus 17]

@andys1027 

So, you will have a taxable gain.  You certainly got the benefit of the gain, since you are now living in a more expensive property.  If the fire had never happened, and you sold for $425K and bought a new place for $425K, you would owe the same tax on the same gain.

From your specific description, your adjusted cost basis is $67K plus $10K for the a/c improvement.  There may be some closing costs from 1985 that can be included as well, you would have to still have a copy of your documents and then review the list of allowable costs in publication 523.

As far as selling expenses, you have to consider three types.

1. Improvements -- something permanently attached to the home that increases its value.   That can also be added to the cost basis.  That would probably be the ceiling fan.  Maybe the blinds if they are permanently attached (my house has plantation shutters that are screwed to the windows, that would count, but fabric blinds probably would not.)

2. Advertising -- that would include staging, but does not include anything that changes the house.  For example, some people paint to help sell, that is not an allowable expense. 

3. Anything that changes the house -- like painting, or blinds.  This is just something you pay for, it does not reduce your gains.

Your selling price is $425K.  The dollar amount of the net proceeds to you are irrelevant and not considered, although some of the adjustments and closing costs are allowed, you would need to read publication 523 and look at your closing statement.

Let's assume that $35,000 of your selling expenses are allowable adjustments, plus $1000 for the ceiling fans.  That means your selling price after adjustment is $389,000.  Let's also assume you can find $1000 of allowable closing costs from your purchase in 1985.  That makes your adjusted cost basis $78,000.  That gives you a total capital gain of $311,000.  After the $250,000 exclusion, your taxable capital gain is $61,000.  

Your income after taxes is not relevant, you look at your gross taxable income, and add the capital gains.  Remember that social security is partly taxable especially if you have other income like a pension.  Based on your total financial situation, some of the $61,000 of gain will be tax-free, but most of it will be taxed at 15%.  So you will likely owe around $9000 in capital gains tax.

Remember you did get the benefit of the gain even if you didn't see the cash.

[andys1027]

FINAL REPLY (So sorry for extending the conversation on this, but your answers have really helped give me some kind of idea of what I might be paying in capital gains):

The original closing on this condo happened on April 1, 1985. I don't think the title company back then is around anymore (I DO have the original deed since the mortgage was paid off in November of 2014). I paid a LOT in interest before the mortgage was paid off (13.5% for 4 years and gradually got the interest down through refinancing to 7.5% interest). I am guessing that interest paid on the original sale price does NOT count? Also, the condo built since the fire, is VERY DIFFERENT from the condo built in 1985 due to new building codes, mandates from the city to include fire proof materials (hey, the condo burned down, after all), high efficient HVAC, double glazed windows, etc. The building (6 condos) is actually 4 foot bigger footprint and stands 4 feet higher...the federal govt. reclassified the condo as 'commercial' instead of 'residential' when it was originally built, and subject to commercial codes like dry walling under the stairs to the basement and basement dry wall ceiling even though it wasn't finished before or after the fire. The HOA declarations/covenants required the HOA to (at the time of the fire) rebuild everything with claim funds from their insurance policy. I also had to continue paying my HOA fee ($393) each month since the fire even though I had no house using water or trash or anything, until it was rebuilt.

ALL records I had from the original build were destroyed in the fire so I have no idea what closing costs and fees I may have paid back in 1985.

I thought simply that I would be paying 20% of the gross sales of this house on Dec. 16th and looking at a tax amount of $62,000 to pay to the IRS- if I can get by with less than $20,000 to pay, I will feel better. All the accountants and CPAs in my area have refused to offer me any help for any rate due to the fact that none of them are taking on new clients, so I am alone and you are the only person to offer some information. I will take your advise and try and decipher the IRS publications you recommend to read to see if I can figure out some idea of what I will be paying and what additional forms are required.

THANK YOU AGAIN FOR YOUR VALUABLE TIME!

-Andy

[Opus 17]

@andys1027 

Interest doesn't count for cost basis.  That the cost of borrowing the money, not the cost of the property itself.

The HOA fee doesn't help, it's not deductible or a cost adjustment.

However (and this brings up an important point about condos), some parts of the HOA fee might adjust your basis, if you paid special assessments for property improvements (not repairs or maintenance).  Suppose that in 2000, the condo association decided to completely renovate the common areas, and your share was $100 per month for 10 years.  If that work met the definition of an improvement (as discussed in publication 523), then the cost of the improvement adds to your cost basis ($12,000 in my example).  But only the cost of special assessments for improvements.  Costs for repairs, regular maintenance, taxes, and so on do not adjust your cost basis.  If you don't remember the details of special assessments for improvements, the HOA might have records that can help you.  

The fact that the rebuilt condo is significantly improved would help you if you had paid for it out of your own pocket, but because it was paid for by insurance, it doesn't help you in the same way.  The insurance payment cancels out the lost value from the fire, leaving you with the same basis you had before the fire. 

Your tax return will include a form 8489 and schedule D, they will automatically be prepared when you indicate you sold your home.  Go to the section for "sales of stocks and other property" and choose "your home" from the list.  You will be asked about the cost, selling price, the dates you bought, sold, and lived in the home, and may a couple other important questions.  You don't need to send any other proof with your tax return, but keep documents related to the purchase, sale and fire for at least 3 years in case of audit. 

[andys1027]

Got it! I only mentioned the HOA fees and the big changes in the rebuilt to add perspective and NOT expecting them to be deductible. So I am guessing that it comes down to: taking the original cost of the home (April 1985) of $67,740.00, adding improvements such as AC, furnace and hot water heater - subtract that from the gross sale price along with the $250,000 exclusion, cost for staging, and ceiling fans and any other allowable adjustments to come up with the total capital gain then taxed at 15%?

[Opus 17]

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@andys1027 wrote:

Got it! I only mentioned the HOA fees and the big changes in the rebuilt to add perspective and NOT expecting them to be deductible. So I am guessing that it comes down to: taking the original cost of the home (April 1985) of $67,740.00, adding improvements such as AC, furnace and hot water heater - subtract that from the gross sale price along with the $250,000 exclusion, cost for staging, and ceiling fans and any other allowable adjustments to come up with the total capital gain then taxed at 15%?

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Basically, yes.  However, if you are single, and use the standard deduction of $14,600, you won't pay any capital gains tax until your total income goes over $61,750.  You haven't been clear on your gross income (you said your after tax income is about 49K).  So it is possible, that part of the gains will be taxed at zero (to bring your taxable income up to $61,750), then 15% on the rest.  So the most you will pay is 15% of $61,750, but it could be a little less. 

Also, let Turbotax do the math.  Enter your cost, selling price, and so forth, and let Turbotax subtract out the $250,000.  If you try and subtract it first, the calculation will end up wrong. 

[andys1027]

Ok...I am single and use the standard deduction. I just checked my GROSS annual income and it is just under $57k which is under the $61,750....do I still pay 15% of that now as capital gains tax or do I add the gross sale of $425k to my gross income, etc.?

[Opus 17 · Accepted solution]

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@andys1027 wrote:

Ok...I am single and use the standard deduction. I just checked my GROSS annual income and it is just under $57k which is under the $61,750....do I still pay 15% of that now as capital gains tax or do I add the gross sale of $425k to my gross income, etc.?

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You are misunderstanding the calculation.  We are estimating that the taxable part of your capital gains after the exclusion will be about $61,000.  Capital gains are taxed at 0%, 15%, or 20%, depending on your total taxable income (all other income including the capital gains).   Based on how the income stacks, the first $5000 of gains will be in the 0% bracket and the remaining $56,000 will be in the 15% bracket.  See illustration.

[andys1027]

Right! I knew I had it wrong....thanks for correcting me! I am roughly guessing that I will owe the IRS around $15,000 - possibly less - based on 15% of the taxable capital gain after deducting the exclusion and all allowable expenses like upgrades (AC, Furnace, hot water heater, etc.) fans for rebuilt, stage furniture and videos for advertising. I will depend on Turbotax to guide me through these questions, since no accountant or CPA is available anytime soon. THANK YOU AGAIN for your guidance and patience!