Tax Saving Strategies for Real Estates
Exclusion of Gain on Sale of Residence, general rules


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 and thefts.

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 HOLDING TITLE

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

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 alone.

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 property.

Co-Ownership

Title to property owned by two or more persons may be vested in the following forms:

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 OF SURVIVORSHIP.

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 hold title.

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 the partnership.

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
.
 
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