Capital Gains

[hlb0530]

My husband and I purchased our primary residence in August 2018. We put in a pool among other upgrades. After living there 2.5 years, we sold it in January 2021. After deducting what we put in it, we made about $30,000. We used that money to buy a house we are currently living in at the end of January 2021. Now due to a paycut at work, we are looking to sell and move so we can downsize and save on our payment. If we sell, we could make possibly make $200,000 off it. Because this would be the second primary house we'd be selling this year, would we pay capital gains on the full amount we make after expenses? We would plan to take the proceeds and buy another home that we'd use as primary residence. Thanks!

[pk]

@hlb0530  to be able to exempt the gain  from the sale of a primary residence  there  are  a few rules  to contend with :

(a) One of you must have owned the property  for at least  two years and both of you  must have used the property as your main residence  for at least 730 days total  during the last five years  starting with the date of sale completion;

(b) you must not have claimed this  exclusion in the last two years.

Thus for your  house  bought in 2018 and sold in  Jan 2021, you do meet the  exclusion requirement and therefore gains may be excluded from taxation for federal purposes.

For your current home, bought in  Jan 2021, if you sell  any earlier than  2023 Feb, you will run afoul of the  both  rules (a) and (b)  above.  Thus  all gains  would be taxable  income.  Also note that  when you flip  ( buy and sell within a short  period of time ), you may not be able to get the capital gain treatment because you held it for less than a year, even though most  realestate  is considered  longterm but ...... 

Suggest that  you consult with financial person  on how to reduce your payments  and be able to take advantage of  gain exclusion  --  ( perhaps refinancing or some other mechanism  would be more appropriate, therefore suggestion to consult with a financial person. 

[Mike9241]

based on what you provided the 2nd home sale will qualify fr a reduced exclusion under REG 1.121-3

(a) In general. In lieu of the limitation under section 121(b) and § 1.121-2, a reduced maximum exclusion limitation may be available for a taxpayer who sells or exchanges property used as the taxpayer's principal residence but fails to satisfy the ownership and use requirements described in § 1.121-1(a) and (c) or the 2-year limitation described in § 1.121-2(b).

(b) Primary reason for sale or exchange. In order for a taxpayer to claim a reduced maximum exclusion under section 121(c), the sale or exchange must be by reason of a change in place of employment, health, or unforeseen circumstances. If a safe harbor described in this section applies, a sale or exchange is deemed to be by reason of a change in place of employment, health, or unforeseen circumstances. If a safe harbor described in this section does not apply, a sale or exchange is by reason of a change in place of employment, health, or unforeseen circumstances only if the primary reason for the sale or exchange is a change in place of employment (within the meaning of paragraph (c) of this section), health (within the meaning of paragraph (d) of this section), or unforeseen circumstances (within the meaning of paragraph (e) of this section). Whether the requirements of this section are satisfied depends upon all the facts and circumstances. Factors that may be relevant in determining the taxpayer's primary reason for the sale or exchange include (but are not limited to) the extent to which -

(1) The sale or exchange and the circumstances giving rise to the sale or exchange are proximate in time;

(2) The suitability of the property as the taxpayer's principal residence materially changes;

(3) The taxpayer's financial ability to maintain the property is materially impaired;

(4) The taxpayer uses the property as the taxpayer's residence during the period of the taxpayer's ownership of the property;

(5) The circumstances giving rise to the sale or exchange are not reasonably foreseeable when the taxpayer begins using the property as the taxpayer's principal residence; and

(6) The circumstances giving rise to the sale or exchange occur during the period of the taxpayer's ownership and use of the property as the taxpayer's principal residence.

The factors seem to meet your circumstances

days or months must be used consistently 

because dates may vary do a separate computation for each spouse

1) number of days (or months) 2nd residence used as main home

2) number of says (or months) 2nd residence owned

3) smaller of 1 or 2

4) number of days (or months) between the date of the sale of the 1st residence and the date of sale of the 2nd residence

5) smaller of 3 or 4

6) divide the number on line 5 by 730 days (or 24 months) 

7) multiply line 6 by $250,000

😎 total line 7 amounts computed for each spouse. this is your reduced exclusion.

so under this scenario, you get to exclude all of the 1st home sale and part of the second.  I think this option excludes the most but there is an option. You can waive the exclusion on the 1st home sale making the gain fully taxable.  the same computation as above is used to compute the exclusion on the 2nd residence but  line 4 is ignored and the number on line 3 goes to line 5

[Opus 17]

The January sale has nothing to do with the current sale.  The idea that you could roll over the gain from one home into a new home was eliminated in 1997.  Each sale is treated separately.

You have a capital gain on the sale of home 1.  You can use your exclusion on that sale to not pay tax on the $30K of gain.

You might qualify for a partial exclusion on the sale of home 2.  See IRS publication 523 on page 8.

https://www.irs.gov/pub/irs-pdf/p523.pdf

If you qualify for a partial exclusion, it will be based on the shortest of three periods:

• the number of days since you last used your exclusion
• the number of days you owned the home
• the number of days you lived in the home as your main home

The exclusion percentage is figured as # of days divided by 730 days (2 years).  For example, if you close November 30 (since it seems you haven't put your home on the market yet), you would qualify for about 300/730 or 41% of the usual exclusion limit.  That would cover a $205,000 gain if you are married filing jointly.  Anything more would be taxed as a short term capital gain at your regular tax bracket.  You will want to be diligent about documenting any closing costs that you can use to adjust your basis so you get the gain as small as possible.  Not all closing costs can be used as basis adjustments, see publication 523.

The date you sold the first home will be one of the factors that determines how much you can exclude on the second home.  If it really makes a difference, you can choose to not use the exclusion on the first sale and pay the tax.  For example, suppose you bought home #2 on January 31, moved in on February 1, but did not close on the sale of home #1 until March 30.  If you use the full exclusion on the sale of home #1 with the regular 2 year rule, then your partial exclusion on the sale of home #2 would be 240/730th instead of 300/730.  But you could choose not to exclude the first home, to get a larger exclusion on the second home.

If you claim the partial exclusion, you don't send any proof to the IRS, but keep your documentation for 6 years in case of audit.

If you don't meet the facts and circumstances test for the partial exclusion, you will pay short term capital gains tax on the entire gain from the sale of home #2.  If you could afford to postpone the sale until it was 366 days since you purchased it, that would significantly lower your capital gains tax rate, possibly from 22% or higher to 15%.

[hlb0530]

Hello again! Thank you so much for all your info. It is appreciated! 

Now I have another question. The 30k we made off the first home does not include closing costs or realtor fees. So after deducting that, we actually made $2,000. With that being said, if we took that as a capital gain, would we be able to use the figures above to determine the amount of days we've lived in our newest home by the 2 year rule to lower our gains on the sale of the second house? Our home is not on the market yet because we are afraid of the potential tax implications from this sale. 

[Opus 17]

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@hlb0530 wrote:

Hello again! Thank you so much for all your info. It is appreciated! 

Now I have another question. The 30k we made off the first home does not include closing costs or realtor fees. So after deducting that, we actually made $2,000. With that being said, if we took that as a capital gain, would we be able to use the figures above to determine the amount of days we've lived in our newest home by the 2 year rule to lower our gains on the sale of the second house? Our home is not on the market yet because we are afraid of the potential tax implications from this sale. 

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The sale of home #2 is completely separate from home #1.  You don't meet the 2 year rule for home #2, and you can't count your ownership of home #1 towards home #2.

Since you don't meet the 2 year rule for home #2, step 1 is to determine if you meet the conditions for a partial exclusion on the sale of home #2.

There are two kinds of tests, listed in publication 523 starting on page 6.  Some of the tests are "safe harbors"—if you meet those exact circumstances, you qualify.  One of those safe harbors is,

 You became unable, because of a change in employment status, to pay basic living expenses for the household (including expenses for food, clothing, housing, medication, transportation, taxes, court-ordered payments, and expenses reasonably necessary for making an income).

This test does not say "you prefer to live more modestly" because of a reduction in income. This test requires that you are financially unable to pay your living expenses.

If you don't qualify for a safe harbor, you might qualify under the non-specific "Other facts and circumstances" rule, which talks about significant financial difficulty.

If you do qualify for the partial exclusion, then step 2 is to consider the effect of the sale of home #1.  Based on the date of the sale of home #1, the date of purchase of home #2, and the date you moved in to home #2, you might be able to increase your exclusion on home #2 by not using the exclusion on home #1.  But you need to look at the overall facts and circumstances.

If you do not qualify for the exclusion on home #2, because your move is a preference and not due to a significant financial hardship, then you should think about making sure your closing date is more than 1 year after the purchase date, because that will probably save you $14,000 or more in taxes, based on your estimate of your gain.  Of course, staying in the house 5 more months  may cost you more than you would save.  That again is up to you. 

[Mike9241]

see my previous response. you say you're selling because you lost your job and can no longer afford it (one factor cited in the regs is the taxpayer's financial ability to maintain the home materially change.  I should point out that your job loss alone would not meet this if your spouse has substantial income or sources of cash to pay for the costs of the home). this would qualify as unforeseen circumstances under code section 121 and the related regulations entitling you to a partial exclusion on the 2nd home.   as others have said the 1st and 2nd sales are completely independent.

use the schedule I provided. use estimated dates to get an idea of the gain that can be excluded. also your gain on the 2nd house would also be reduced by selling costs.  don't wait to put it on the market. you could lose out on qualifying for the partial exclusion if you wait too long to sell after moving out. of course the longer you stay in the house the more days on ownership and use and thus the higher the partial exclusion. 

[Opus 17]

@Mike9241 

Taxpayer says “paycut” not lost job.  The substance of the regulation seems to be that the family must be in true financial hardship, rather than simply having a preference for a more affordable lifestyle.  Whether they are experience true hardship is something only they can really say.  

[VolvoGirl]

Back to the first house sale, just checking, the 30K you made,  was that your proceeds from the sale (before costs) or the actual Profit before paying off any mortgage, etc.?  The actual gain or loss is the

Sales Price-fees  minus

the original Purchase Price+fees+improvements

The net proceeds you got doesn't matter.