Saving Strategies for Real Estates
Exclusion of Gain on Sale of Residence, general
A taxpayer may exclude from income up to $250,000 realized on the
sale or exchange of a residence. For certain married couples filing
a joint return, the maximum amount of tax-free gain doubles to $500,000.
Like most tax breaks, however, the exclusion has a detailed set of
rules for qualification. Besides the $250,000/$500,000 dollar limitation,
the seller must have owned and used the home as his or her principal
residence for at least two years out of the five years before the
sale or exchange. In most cases, sellers can only take advantage of
the provision once during a two-year period. However, a reduced exclusion
is available if the sale occurred because of a change in place of
employment, health, or other unforeseen circumstances (that IRS may
specify in future regulations). Where the exclusion wasn't used on
another home sale within the previous two years, the amount of the
reduced exclusion equals a fraction of the $250,000/$500,000 dollar
limitation. The fraction is based on the portion of the two-year period
in which the seller satisfies the ownership and use requirements.
These rules can get quite complicated if you marry someone who has
recently used the exclusion provision, if the residence was part of
a divorce settlement, if you inherited the residence from your spouse,
if you sell a remainder interest in your home, or if you have taken
depreciation deductions on the residence.
Like-kind Exchanges, general rules
A like-kind exchange is any exchange (1) of property held for investment
or for productive use in your trade or business for (2) like-kind
investment property or trade or business property. For these purposes,
"like-kind" is very broadly defined. As long as the exchange
is real estate (land and/or buildings) for real estate, or personal
property (non-real estate) for personal property, it should qualify.
However, exchanges of some types of property (for example, inventory
or shares of stock), do not qualify.
Assuming the exchange qualifies, here's how the tax rules work:
If it's a straight asset-for-asset exchange, you will not have to
recognize any gain from the exchange. You will take the same "basis"
(your cost for tax purposes) in your new property that you had in
the old property.
Frequently, however, the properties are not equal in value, so some
cash or other (non- like-kind) property is tossed into the deal. This
cash or other property is known as "boot." If boot is involved,
you will have to recognize your gain, but only up to the amount of
boot you receive in the exchange. In these situations, the basis you
get in the like- kind property you receive is equal to the basis you
had in the property you gave up reduced by the amount of boot you
received but increased by the amount of gain recognized.
Example. Ted exchanges land (investment property) with a
basis of $100,000 for a building (investment property) valued at $120,000
plus $15,000 in cash. Ted's gain on the exchange is $35,000: he received
$135,000 in value for an asset with a basis of $100,000. However,
since it's a like-kind exchange, he only has to recognize $15,000
of his gain: the amount of cash (boot) he received. Ted's basis in
his new building will be $100,000: his original basis in the land
he gave up ($100,000) plus the $15,000 gain recognized, minus the
$15,000 boot received.
Note that no matter how much boot is received, you will never recognize
more than your actual ("realized") gain on the exchange.
If the property you are exchanging is subject to debt from which you
are being relieved, the amount of the debt is treated as boot. The
theory is that if someone takes over your debt, it's equivalent to
his giving you cash. Of course, if the property you are receiving
is also subject to debt, then you are only treated as receiving boot
to the extent of your "net debt relief" (the amount by which
the debt you become free of exceeds the debt you pick up).
Involuntary Conversions, general rules
When property is converted involuntarily or by compulsion into other
property similar or related in service or use to the converted property,
recognition of gain can be deferred. When property is involuntarily
converted into money, gain need not be recognized if an equal amount
is spent to acquire property similar or related in service or use
to the converted property. Involuntary conversions include condemnations
(a disposition under the threat or imminence of condemnation), casualties
The gain realized from a condemnation award is the difference between
the award (the amount realized) and the adjusted basis of the condemned
property. The amount realized is reduced by the taxpayer's legal fees,
engineering costs, and other expenses necessitated by a condemnation
proceeding. However, sums withheld from the award to pay liens on
the property do not reduce the amount realized.
The replacement of condemned real estate held for productive business
use, or for rental or investment, qualifies for nonrecognition treatment
if the replacement property is property of a "like kind."
The test for determining whether replacement property is of like-kind
is more liberal than the "similar use" rule. Like-kind refers
to the nature, character, or class of the property, not to its grade
or quality. It doesn't matter where the property is located, or whether
it is unimproved or improved.
Converted property must be replaced within a period: beginning with
(a) the date the property was destroyed, stolen, condemned, etc.,
or (b) the date condemnation or requisition was first threatened or
became imminent, whichever is earlier, and ending (a) two years after
the close of the first tax year in which any part of the gain is realized
(three years in the case of condemnation or threat of condemnation
of real property used in a business or held for investment; four years
for principal residences converted as a result of presidentially declared
disasters), or (b) at a later date allowed by the IRS on application
by the taxpayer.
FORMS OF OWNERSHIP: COMMON METHODS OF
How Do I Take Ownership of the Property I Am Buying?
This important question is one California real property purchasers
ask their real estate, escrow and title professionals every day. Unfortunately,
though these professionals may identify the many methods of owning
property, they may not recommend a specific form or ownership, as
doing so would constitute practicing law.
Because real property has become increasingly more valuable, the question
of how parties take ownership of their property has gained greater
importance. The form of ownership taken - the vesting of title - will
determine who may sign various documents involving the property and
future rights of the parties to the transaction. These rights involve
such matters as property taxes, incoming taxes, inheritance and gift
taxes, transferability of title and exposure to creditor's claims.
Also, how title is vested can have significant probate implications
in the event of death.
The California Land Title Association (CLTA) advises those purchasing
real property to give careful consideration to the manner in which
title will be held. Buyers may wish to consult legal counsel to determine
the most advantageous form of ownership for their particular situation,
especially in cases of multiple owners of a single property.
The CLTA has provided the following definitions of common vestings
as an information overview. (Consumers should not rely on these as
legal definitions.) The Association urges real property purchasers
to carefully consider their titling decision prior to closing, and
to seek counsel should they be unfamiliar with the most suitable ownership
choice for their particular situation.
Sole ownership may be described as ownership by an individual or other
entity capable of acquiring title. Examples of common vestings in
cases of sole ownership are:
1. A Single Man/Woman:
A man or woman who has never been legally married. For example: Bruce
Buyer, a single man.
2. An Unmarried Man/Woman:
A man or woman who was previously married and is now legally divorced.
For example: Sally Seller, an unmarried woman.
3. A Married Man/Woman as His/Her Sole and Separate Property:
A married man or woman who wishes to acquire title in his or her name
The title company insuring title will require the spouse of the married
man or woman acquiring title to specifically disclaim or relinquish
his or her right, title and interest to the property. This establishes
that it is the desire of both spouses that title to the property be
granted to one spouse as that spouse's sole and separate property.
For example: Bruce Buyer, a married man, as his sole and separate
Title to property owned by two or more persons may be vested in the
1. Community Property:
A form of vesting title to property owned by husband and wife during
their marriage which they intend to own together. Community property
is distinguished from separate property, which is property acquired
before marriage, by separate gift or bequest, after legal separation,
or which is agreed to be owned by one spouse.
In California, real property conveyed to a married man or woman is
presumed to be community property, unless otherwise stated. Since
all such property is owned equally, husband and wife must sign all
agreements and documents of transfer. Under community property, either
spouse has the right to dispose of one half of the community property,
including transfers by will. For example: Bruce Buyer and Barbara
Buyer, husband and wife as community property.
2. Joint Tenancy:
A form of vesting title to property owned by two or more persons,
who may or may not be married, in equal interest, subject to the right
of survivorship in the surviving joint tenant(s).
Therefore, joint tenancy property is not subject to disposition by
will. For example: Bruce Buyer and Barbara Buyer, husband and wife
as joint tenants.
3. Tenancy in Common:
A form of vesting title to property owned by any two or more individuals
is undivided fractional interests. These fractional interests may
be unequal in quantity or duration and may arise at different times.
Each tenant in common owns a share of the property, is entitled to
a comparable portion of income from the property and must bear an
equivalent share of expenses. Each co-tenant may sell, lease or will
to his/her heir that share of the property belonging to him/her. For
example; Bruce Buyer, a single man, as to an undivided 3/4 interest
and Penny Purchaser, a single woman, as to an undivided 1/4 interest,
as tenants in common.
4. Community Property with Right of Survivorship:
Effective with any deeds created after July 1, 2001, a new form of
holding title will be available to all husbands and wives holding
title to California real estate. This is COMMUNITY PROPERTY WITH RIGHT
Upon the death of one of the spouses, title held under joint tenancy
always passes to the survivor. Under present law, joint tenancy can
be terminated upon the death on one of the spouses, by the recordation
of a death certificate and an affidavit of death.
Currently, upon the death on one of the spouses under community property,
title passes to whoever it is will to, this may be the surviving spouse
or someone else. If the property is willed to the surviving spouse,
then the title can be transferred by the recordation of a death certificate
and an affidavit of death, similar to joint tenancy. If the property
is willed to someone other than the surviving spouse, it may require
a probate of the estate.
Community property may be beneficial compared to joint tenancy in
that upon the death of one of the spouses, the property gets a stepped-up
basis which may result in estate tax, or inheritance tax savings.
The stepped-up basis becomes more important the longer a couple owns
a piece of property and the more the property appreciates.
Under the new law, if a couple selects Community Property With Right
of Survivorship, the title will pass only to the surviving spouse
and not to someone else. Because of this, Community Property With
Right of Survivorship may not be the best way for every couple to
People will be able to transfer title of COMMUNITY PROPERTY WITH RIGHT
OF SURVIVORSHIP by executing and recording a deed to themselves after
July 1, 2001. California Land Title of Marin will be able to assist
clients with this transfer.
Other Ways of Vesting Title Include As:
1. A Corporation:
A corporation is a legal entity, created under state law, consisting
of one or more shareholders but regarded under law as having an existence
and personality separate from such shareholders.
2. A Partnership:
A partnership is an association of two or more persons who can carry
on business for profit as co-owners, as governed by the Uniform Partnership
Act. A partnership may hold title to real property in the name of
3. A Trust:
A trust is an arrangement whereby legal title to property is transferred
by the grantor to a person called a trustee, to be held and managed
by that person for the benefit of the people specified in the trust
agreement, called the beneficiaries.
* In cases of corporate, partnership or trust ownership the title
company will require that it be furnished legal documents so that
it may satisfy itself as to ownership rights of the parties to the
transaction and any limitations which may exist on the sale, transfer
or encumbrance of the property. Required documents may include corporate
articles and bylaws, certificates of partnership and trust agreements.