Last article we unlocked some of the secrets regarding Prop 60- 90, where an over 55 years of age owner, planning to trade down, can transfer their low Proposition 13 base year tax value from a former residence to a lower cost replacement residence.
As you recall, these propositions allow an owner to maintain a low cost property tax payment thus avoiding a costly tax reassessment required by the County Assessors office on any new real estate purchase.
Currently Los Angeles, Orange and San Diego counties allow this property tax transfer to a lower cost residence. This week we will open the other part of the combination, Internal Revenue Code 121, and review the conditions under which an owner(s) can sell a personal residence and avoid taxable capital gains on proceeds of the sale of up to $500,000 in profits thus freeing up substantial equity for a new trade down purchase.
Prior to 1997, should an owner wish to sell a personal residence, they were required to purchase a more expensive home in order to bypass the capital gains trigger and resulting capital gains tax. Rules required owners to reinvest in a more expensive residence within a tight time frame.
Miss the time frame and the sale of your prior residence would become taxable. There were some once in a lifetime provisions exempting up to $125,000 in capital gains profit if you were over 55.
But in any event, during this period trying to trade down and retire or just sell and rent was not a tax friendly event and the IRS was waiting in the wings as your tax partner should you try to do so.
In 1997 Congress revised IRC 121. The exemption is now open to everyone. The law basically states that an individual can exempt up to $250,000 in capital gains and up to $500,000 for a couple filing jointly on the sale of their personal residence.
This is one of the biggest tax breaks available for a seller, said Matt Murphree of Prospect Mortgage in Seal Beach. Everyone should understand and take advantage of it.
There are some fairly straightforward rules concerning whether an individual or married couple can obtain this tax break. Some of the rules are:
The owner(s) are required to have resided in the home in the aggregate for at least two of the last five years and the home must be classified as a personal residence.
Only one spouse needs to hold title, but the titleholder must qualify in order to receive the exemption.
The tax break cannot be used more than once every 24 months.
If a husband and wife wish to claim the exemption of up to $500,000, both must meet the occupancy test and file a joint tax return in the year of the sale.
Occupancy need not be continuous, nor must the residence be the sellers principal home at the time of sale.
If the residence is in a family/living trust, the exemption still applies. Vacation homes, rental properties or second homes do not qualify.
Partial prorated exemptions are available for owners who have occupied their home less than two years, and were forced to sell because of a personal situation, i.e. change in job location, health reasons and other unforeseen circumstances.
Should you desire to move down to a smaller, more efficient residence, with lower monthly cost combining Prop 60/90 and IRC 121 you will have the key to a successful trade down saving thousands in tax and monthly property tax fees.
As a reminder, in all cases relating to tax matters please contact your tax advisor for a complete list of the rules for qualifying for this exceptional tax break.
Arthur Carlson is a broker associate with Main Street Realtors with an office located at 1400 Ocean Ave. in Seal Beach. He can be reached online at www.ArthurCarlson.com or by phone at (714) 815-1833.
