Capitol Gains for engaged couple who own property together

[h2oskigirl]

Hi, 

My fiance and I purchased a home in July 2013 for $520000.  We are selling the home this month (Nov 2018) for $900000.  Total we owe on the mortgages is about $525000.  We also put about $100000 ($40000 of that was borrowed for our 2nd mortgage) into the backyard over the course of the 5 years we lived there.  We also will be paying $45000 to the realtors during the sale of the home.  My question is whether we will have to pay capitol gains taxes on the profit of the sale.  The home is in both of our names, but he has written it off while we lived there, my name alone is on the 1st, and we are both on the 2nd.  We have talked about a shotgun wedding (by the end of the year)  to avoid the taxes (no capitol gains if profit is < $500,000 for married couples), but that is a lot on our plates with work, kids, and holidays upon us.  Of note, both of our current tax bracket for us both is 24%.

Any help is appreciated! 

[Carl]

For starters, being married or not has nothing to do with, and has absolutely no bearing what-so-ever on the capital gains exclusion. If *YOU* lived in the house for at least 2 of the last five years you owned it, then *your* first $250K of gain is tax exempt on *your* tax return. If your BF lived in the house for at least two of the last five years he owned it, then *his* first $250K of gain is tax exempt on *his* tax return.

So regardless of marital status (which has no bearing at all on this)  if an owner did not live in the house as their primary residence for at least 2 of the last five years they owned it, then that owner does not get any exclusion.

Note that even if you were married, and say for example you lived in the house but your BF did not. Then on your joint return you would only qualify for a $250K tax exclusion of the gain, and that's it. So marital status has absolutely nothing to do with it.

[h2oskigirl]

Thanks for the reply.  We purchased the home together and both lived in the house for the entire time.  We just filed taxes the way we did because it was easier than splitting and me claiming 1/2 the house and him claiming the other 1/2.  Our $ was all together that entire time, as well, we just never got married.  Anyway, as I understand your reply, we both can make up to $250K ($500K total) on the sale of the home before paying taxes on it, correct?  I have just read that married couples can make $500K on the sale of a home before paying taxes on it, thus the question about us getting married quickly.  We close in the next few weeks.

Thanks again!

[Carl]

First, understand the exclusion requirement.  The requirement is that you lived in the house as your primary residence for at least two of the last five years you owned it. That does not mean you have to own the house for five years. You could have owned the house for 2 years and one day. But so long as you lived in it as your primary residence for at least 2 years, you qualify for the exclusion. I know people who over the last 7 plus years who have sold a house that qualified for the exclusion, moved into their new digs and then 2 years later sell again and get the exclusion.

we both can make up to $250K ($500K total) on the sale of the home before paying taxes on it, correct?

Yes. Where folks tend to get confused is they think that if married and filing a joint return, they can get a $500K exclusion if only one of them lived in the house. That's just not true. When filing a joint return, there is a $250K exclusion for "each" tax filer listed on the joint return, that lived in the house. So if both tax filers lived in the house for 2 years, they get a $500K exclusion on their joint return. If only one of them lived in it for 2 years, then they only get a $250K exclusion on their joint return.

We just filed taxes the way we did because it was easier than splitting and me claiming 1/2 the house and him claiming the other 1/2.

That's fine. But dividing everything by two really isn't that difficult. 🙂 Besides, that's exactly what you'll be doing to report the sale, so each of you get the $250K exclusion on your individual tax returns, for a total of $500K between the two of you.

We close in the next few weeks.

Assuming you two will not be married on or before Dec 31 of 2018, and further assuming that you will close before that same date, you will each report your half of the sale on your individual tax returns. Then if you both lived in the house for 2 years *AS YOUR PRIMARY RESIDENCE* (that's the requirement) then you will *each* get a $250K exclusion on your individual tax returns.

Now, a few things I want to point out.

purchased a home in July 2013 for $520000.  We also put about $100000 ($40000 of that was borrowed for our 2nd mortgage) into the backyard over the course of the 5 years we lived there.

What you did very well may be what is termed "property improvements". Those are things you do to the property that add value to it. So for example if you had the backyard graded, installed a fence, a pond and/or a below ground pool, those are property improvements and those cost of those improvements add to your cost basis. So if you purchased the property for $520K and put another $100K into property improvements, your cost basis on the property is $620K. So without considering deductible closing costs and sales expenses, you have a raw gain of $280K on the property.

So what is a property improvement? The IRS has a clear definition of what constitutes a property improvement.

1) The improvement must become "a physical part of" the property. For example, new cabinets in the kitchen, new roof, adding on a room, replacing that old central air unit with a new one, etc.

2) The improvement must add "real" value to the property. In other words, when appraised by a qualified, certified, licensed property appraiser, they will appraise it at a higher value than they would have without the improvements.

So for example, painting the house does not qualify as a property improvement. While the paint does become "a material part of" the property, from the perspective of a property appraiser it doesn't add one penny of "real" value to the property. People aren't buying the house for the color of the paint, and it's highly probable they won't like the color anyway.

However, when you do something like convert a part of a 3 car garage into a bedroom, you are of course going to paint it. Making what was once a 2 bedroom house into a 3 bedroom house will add "real" value to it. But you will include the cost of painting as a part of the overall improvement cost - not as a separate expense from it.

So for determining your "true" cost-basis in the property for determining gain on your sale, you will need to determine what expenses of the $100K you spent will qualify as a property improvement to add to that original purchase price cost basis.