TC People across the nation share a common problem -- it's hard to sell a house. Some homeowners forge ahead and trade up to a new home before their current home is sold. They often live to regret it.
Before moving, be sure you understand the tax and cash flow implications of such a bold action in this rough market, warns Bill Methenitis, real estate attorney with Dallas-based Strasburger & Price, and contributor to Matthew Bender's Federal Tax Service.
Most people try to sell their home within two years after buying their new home. That is the time limit the government sets for "rolling over the profits" without paying taxes. If you do not sell your house within two years of buying a new one, you eventually will pay capital gains taxes.
What most commonly happens when you try to sell or buy a home -- quite likely the largest investment of your lifetime? Methenitis suggests three possibilities and some tips for each situation:
1. You are moving, you think you can sell your house, but you know it will take time to sell it.
* You can "tread water" by renting your old house while you wait to sell it. As long as you sell within a two-year period, you still will qualify for tax rollover of the capital gains from the sale, provided your motive remains sale and not rental.
* There are important records to keep. Get advice from a lawyer or accountant.
* You can deduct a limited amount of expenses involved in maintaining the house for rental.
* Keep in mind that you are selling your house -- don't sit back. If your mortgage payments are higher than the rent you can get, you will dig in your pockets each month for payments on two houses.
2. After two years, you have still not been able to sell your house.
* Now that you haven't sold your house within the rollover period, consider renting it and waiting until its value increases. You will pay capital gains taxes when you sell.
* Rollover rules are cumulative. The cost basis you have in your present home always equals your cost, minus your gain, rolled over and not recognized on all prior homes.
Once you have passed the two-year time frame, there is no point in categorizing the house "for sale." Classify it as rental property. Having done this, you will qualify for all rental property deductions.
* You also now will qualify for rental real estate exclusions that are part of the passive loss rules, one of the few tax shelters still available. If you show a loss from rental real estate activities, you can deduct up to $25,000 of that loss against other income such as salaries and interest. This exclusion begins to phase out for taxpayers with adjusted gross income over $100,000.
3. Your house has not sold and you are losing money -- the house's value is decreasing.
* Don't expect to deduct the loss when you sell. If you paid $120,000 for your house and it's now worth $100,000, you cannot deduct a $20,000 loss when you sell it.
* Because you cannot deduct your loss on personal use property, one way to turn a negative into a positive is to convert the house to a rental house, which becomes a business property. You cannot deduct the loss that occurred before conversion, but a loss after the conversion is deductible.
* If you want to convert your home to a rental property (either because you are past the two-year rollover period or because you anticipate a tax loss), you must document your profit motive. If your house is a rental property, be sure to report it that way, and not as a second house.
* If you have a vacation house, plus the house you are selling and a house you just bought, be aware that you can deduct mortgage interest for only two houses. Turning the house you are selling into a rental house will allow interest on the vacation home to be deductible.