Most homeowners are now clear on the ability to pocket up to $500,000 of tax-free capital gain ($250,000 for single people) on the sale of a primary residence. The huge benefit, which can be used every two years, was made possible by the Taxpayer Relief Act of 1997.
While most families do not move every two years, the tax-free possibility does exist for folks who may face a job transfer or for others who simply wish to take advantage of rapidly appreciating markets – such as the Puget Sound region.
Can you imagine: Sell your home in Edmonds, pocket the gain, move to Poulsbo, sell two years later, pocket the gain, move to Gig Harbor.
However, the tax law that provided the new capital help did nothing for capital losses. There still is no benefit for folks who made expensive remodels then had to sell in a hurry and actually got less for their home than the cash they had invested in it. Long-term capital expenditures usually pay off over time, but big changes for the short term are difficult to recover.
A recent caller to our radio program made significant home modifications to her residence to enable her mother to age in place. Her mother died shortly after the remodel, and the woman was transferred to another city. The net sales price was less than the total amount invested in the home.
With the end of the year just around the corner, don’t count on chalking up a capital loss as a big tax deduction. There still is no deduction for a capital loss on the sale of your primary residence. This often causes confusion and provokes questions from consumers, but Uncle Sam will not let you show a loss if you sell for an amount less than the purchase price.
Why? The principal residence has always been viewed as a personal asset. The gain on the sale of a principal residence has been taxable as a capital gain, but losses have never been allowed. Although the capital gain thresholds have been increased, proposals to address capital losses have been defeated.
The confusion surfaced again a few years ago when several parts of the “Contract With America” included tax law changes. A proposal to allow tax deductions for losses on the sale of a principal residence was part of that package, but did not make the cut.
Although home values are rising in most regions of the country, some have been flat. In addition, more than a few potential home buyers get emotionally carried away when bidding for a home. In some cases – especially where there are multiple offers – the offer can exceed the fair market value of the home. In a flat market, it could years to recover an overbid. Those buyers often must move again before the market catches up.
The capital loss proposal stemmed from complaints from homeowners in the Sun Belt and New England who said they were left with huge losses and no federal tax help when home values plunged during the 1990s – especially when the declining oil industry in Texas shook the housing market around Houston.
Another hotly debated issue this time of year is the deductibility of loan fees. You can deduct the loan fees (points) paid to buy or improve your main home in the year of purchase. You cannot deduct these fees in the year you refinanced if you refinanced only to obtain a lower interest rate on your loan.
The term points, once used to describe only prepaid interest on government loans, now is used to describe charges paid by an owner to secure any mortgage. These points can be loan origination fees or prepaid interest to buy down an interest rate. To be deductible, these charges must represent interest paid for the use of money and must be paid “before the time for which it represents a charge for the use of the money.”
According to the Internal Revenue Service, most points paid when you are refinancing an existing mortgage must be written off over the life of the new loan. For guidance on closing costs, the best source may be the settlement sheet from the original loan.
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