Exclusion Rules on Sale of Principal Residence
To maximize the
net cost purchase price to the contract price you must add the closing
costs- legal, mortgage recording, insurance, hazard, etc as per the HUD
settlement statement to bump up the cost to your net costs on purchase.
To that you would add subsequent improvements and additions.
goal of this article is to provide a comprehensive checklist of information
to consider prior to filing a tax return. This article
is not designed to teach you the technical competence required to perform
self compliance, however it will certainly arm you with the knowledge to
determine if your US tax preparer knows all that they should know to provide
you with technically competent professional services.
rules on Sale of a Principal Residence:
If the home
is your “main home” or principal residence in the five year window prior
to sale you must have: 1) owned and 2) used or lived in the home for at
least two years= 24 months = 730 days for both spouses to qualify for the
$250,000 per spouse exclusion.
The two years
for the owned and use test do not have to be the same two years within
the five years prior to sale. Further the determination of “main
home” is made on an annual basis, such that there may be multiple “main
home” determinations in any five year window. The use test does not
require 730 consecutive days of use, as long as there are any 730 days
in the corresponding five year window and may occur during periods of non-ownership.
Temporary absences even if rented out are counted as periods of use.
Lastly this exclusion may only be used once every two years.
If you do not
have the two years for both tests you will not qualify for the exclusion
unless: you have a change in location of employment, health reasons or
for unforeseen circumstances. In such cases the exclusion is prorated
by qualifying days over 730 days.
handicap for expats or foreigners here in the US on assignment is that
although they usually meet the two year test of ownership they DO NOT meet
the test on use.
If the home
is NOT your "main home" or principal residence or you do not meet the above
tests and you have held the residence for more than one year then the gain
would be taxed at the long term capital gain rate, which is currently 15%.
the Net Unexcluded Gain on Sale:
They key to
minimizing your capital gain on sale subject to the US long term
capital gains tax rate, is to minimize your net capital gain. The
net capital gain is comprised of the net proceeds less the net costs.
By minimizing net proceeds and maximizing net costs, the closer these two
amounts become. The closer these two amounts become, the smaller
the resultant capital gain. Although gross proceeds and gross costs
are readily determinable, the net amounts may be more elusive to calculate.
To do this you will need the HUD closing and settlement statements, or
the foreign equivalents of these documents.
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net sale proceeds you would reduce from gross proceeds broker commission,
legal, etc as per the HUD settlement statement to reduce the net gain as
small as possible. Of course this should be attempted only with the
guidance and expertise of a Certified Public Accountant (CPA).
your Principal Residence while Abroad/ in the US:
If you decide
to maintain your US or foreign residence while living abroad or while living
in the US, the mortgage interest and real estate taxes are deductible in
the year that they are paid on Schedule A of Form 1040. As US resident
aliens- whether by US citizenship, US permanent residency (green card)
or those that meet the Substantial Presence Test (SPT) as your worldwide
income is US taxable, as does your worldwide deductions become US deductible.
out a non US residence or a US residence, as a US resident alien worldwide
taxability becomes a factor. In the US net rental activity is reported
on IRS Form 1040- Schedule E. Schedule E supports inclusion of calendar
year cash received rental income as well as a host of straight forward
deductions, including: mortgage interest, real –estate taxes, cleaning,
maintenance, repairs, commission, insurance, advertising, management fees,
supplies, utilities, legal and professional, travel, and others such as
snow removal, condo fees, etc…
depreciation is a mandatory deduction, so claiming it is important.
Otherwise you are deemed to have claimed it. For US located rental
properties the depreciation rate is 27.5 years straight line, while for
foreign properties the rate is 40 years straight line.
On sale there
is a recapture of this prior claimed depreciation that in effect is retracted
from the gain on sale exclusion calculation to form part of a fully taxable
activity is considered a passive activity. Passive activity losses
are only allowed to the extent of passive activity gains or income.
Although there is a Special Allowance for rental real estate with active
participation, for persons with adjusted gross income under $150,000 to
a maximum special allowance of $25,000. Failing this the passive
annual rental losses are suspended indefinitely and carried forward until
either the property or group of properties is sold or income drops below
the $150,000 barrier at which point the suspended losses are triggered.
There is a
special election IRC Sec. 469(j)7) to treat the mortgage interest of a
principal residence rented out as in effect by passing the passive activity
rules, therefore in effect triggering a rental loss to the extent of the
mortgage interest annual claim. This mortgage interest would be termed
Qualified Residence Interest. However these rules have been recently
challenged and aggressively audited by the IRS ensuring that the home meets
the Qualified Residence rules as delineated in IRC Sec. 121. Basically
the home must be your main home where one may not have more than one main
home at any time and the determination depends on the facts and circumstances
of each case. However it stands that a rental that lasts for several
years may indicate that the property is no longer a principal residence
and, therefore may no longer qualify as Qualified Residence Interest eligible
for the IRC Sec. 469(j)(7) election.
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