As Ben Franklin famously put it, “In this world nothing can be said to be certain, except death and taxes.” It was true then and it is true now. Just about every day I meet someone that says “I’d love to move but the taxes will kill me!” Believe me, I understand – I spent several years as an accountant and I have yet to meet anyone that is excited about paying taxes – especially taxes on something you’ve already been taxed on, like your home.
Many of you reading this have plenty of equity in your home, which is undoubtedly a good thing, but even with a capital gains exemption of up to $500k when you sell, you still fear the potential tax bill, not to mention the potential increase in property taxes if you were to buy a replacement property. So what can you do? There’s some good news; in fact, there are several strategies you can use to save some money. I’ve Identified 4 ways below to save money on taxes for property owners.
Homeowners Exemption – Most homeowners in Southern California who live in their home as their primary residence are eligible for a $7,000/year reduction in their assessed value. This translates to at least a $70/year savings in property taxes. How do you know if you are receiving this exemption? Your property tax bill will indicated if you are utilizing the exemption. Or feel free to call our office (310-483-3998) or send us an email (kyle@kyledanielsrealestate.com) to see if you are receiving this exemption and if not, we’ll gladly send you a form to apply. I know it’s not much to get too excited about, but if I knocked on your door and handed you $70 bucks every November, you’d probably take it. Here’s a link to the LA County Assessor’s Website if you would like to learn more.
Proposition 19 – While we’re on the topic of property taxes, there is a second option to save money for those that are thinking of selling your home this year. If you are 55 and older and decide to sell your home and move to another residence in California, you may be eligible to transfer your property tax basis from the home you are selling. Because of Proposition 13, many of you have a low property tax bill, especially if you bought your home several decades ago. If you decide to move within the state, Proposition 19 allows you to transfer this basis to your new home. For example, let’s say you sell your home for $2.5 million and buy a smaller condo at the beach for $1.5 million. Say you paid $250k for your home and the assessed value is now $450k. Instead of paying taxes on the new home assessed at $1.5 million, you use your Prop 19 base year transfer and continue paying property taxes on the $450k. In math terms, that would look something like this: Past tax bill: $5,400/year | Potential new tax bill: $18,000/year | Savings $12,600!
Capital Gains Exclusion – If you’ve lived in your home 2 out of the last 5 years, Uncle Sam has given you a real deal. Known as the Section 121 Exclusion, you can exclude $250k ($500k if married filing joint) from capital gains when you sell your home. With the top earners being taxed at 20% on long-term capital gains, plus another 3.8% for the Obamacare surcharge, you are looking at a hefty tax bill. Don’t forget to add capital improvements (additions, new roof, etc) to your basis value to reduce your gains. It’s also important to note that it is the aggregate of 2 years within the last 5 years – so if you have a second home or have been renting your home part time, you can still qualify as long as the time adds up to 2 years. What if you are like the family in the example above and you sell for $1.7m after buying for $250k? Because only $500k would be sheltered, you may need another option to save. See option 4 below. (Note: Nearly 2 years ago the “More Homes on the Market Act,” a bipartisan assembly bill, was introduced by Jimmy Panetta (D-CA) and Mike Kelly (R-PA) to increase the capital gains exemption to $500k/and $1m. It has not moved forward but in the House but perhaps it will be back on the agenda with the incoming administration.)
Section 1031 Exchange – So when all else fails and you you’ve tried options 1, 2, and 3 above, what can you do if you are still looking at a huge taxable gain when you sell your home? The last option is tax deferment. In this case, the Section 1031 like-kind exchange is your last option (you could also consider a monetized installment sale but I’d have to refer you to a tax-attorney for more advice on that option – call me and I’m happy to refer you). In a 1031 exchange, you sell one property and purchase another. But there’s a catch. This exchange only works for investment or business property. In the words of the IRS, “if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized.” How does this work if you want to sell your primary residence? First, you need to be willing to rent out your home for a year or more. The IRS isn’t specific about the amount of time, but many CPAs advise at least a year to consider the home investment property. Be sure to report the rental on Schedule E of your tax return for supporting evidence of your rental property. Once you have converted your residence to income property, you sell the home. With the use of an exchange accommodator, the funds from your sale goes to the accommodator until you purchase your “upleg” like-kind property (you have 180 days to complete the purchase). Continuing the example above, you sell your home for $1.7m. You subtract the basis (purchase price) plus related expenses to determine your gain, in this case we’ll call it $1.35m. $500k will be exempt using the Homeowners exclusion for the 2 years you lived in the property. The remaining $850k would be subject to capital gains (in California that could be over $300k); however, if you exchange your equity for another investment property, say a duplex in Torrance grossing $5k/month in rent, you’ll shelter the gain and have another source of income while you’re at it. Eventually, the deferred gain will catch up with you if you or your heirs decide to sell the investment property, but for now you will have sheltered your gains from income taxes.
I should explain that even the most basic tax calculation can be complicated, so it is recommended that you consult with a CPA or Tax Attorney before acting on any of the above concepts. I’m happy to sit down with you to discuss in greater detail the tax tips above and help strategize and get you started in the right direction to reach your goals.
