Orange County Estate Planning Lawyer Blog
Subtitle: Pull out tax free gain while downsizing
INCOME TAX “GAIN” CONCEPT
Under our system of federal and state income tax, if your personal residence is sold before death for more than what was paid for it then there is a capital gain. For example, if you purchased your home for $100,000 and sell it for $300,000 there would be a capital gain of $200,000. The capital gain is reported as income on your personal income tax return. Figure roughly a combined federal and state tax on the $200,000 gain of 1/3rd which would be $66,666.
EXCLUSION OF GAIN IF PERSONAL RESIDENCE
An individual may exclude up to $250,000 in gain and a married couple may exclude up the $500,000 on a joint return if the property was the “personal residence”. A personal residence is defined under the tax law as a residence used as your principal residence for periods aggregating two years (730 days) during the five years leading up to the sale. Thus, you don’t have to actually have to be living in the residence at the time of the sale if you meet the 2 year test. Short temporary absences and vacations are counted as part of the 730 days.
RETIREMENT AND DOWNSIZING
With this tax rule, you can downsize and move to a different residence for retirement without incurring any capital gains tax on the first $250,000 or $500,000 for a married couple. One scenario would be to take out a loan on your original residence and then use that for purchase of the retirement home and then sell the original residence and pay off the loan-all free of taxes.
TWO YEAR FREQUENCY LIMIT
You can only use this gain exclusion once every two years. This actually can be a powerful estate builder in that you can keep getting into larger and more expensive residences by using the untaxed capital gains of up to $500,000 per year for a married couple.
A SURVIVING SPOUSE CAN DO THIS
A surviving spouse can use the full $500,000 gain exclusion if the sale of the residence is made not later than two years following the death of the first spouse. The sale must occur however before the surviving spouse remarries or else the $500,000 exclusion drops back to $250,000.
CALL (949) 851-1771 to speak with Lawyer David L. Crockett
FURTHER BENEFITS IN SOME SITUATIONS
There are aspects of this law which benefit divorced and incapacitated individuals. Also there is relief for persons in the military and persons who are forced to move for employment or health reasons. These situations are beyond the scope of the article and you are advised to consult a qualified tax professional before actually selling your personal residence no matter what the circumstances to determine all of your options.
