On Houses and Taxes

The Wall Street Journal (subscription required) has an article today on the increasing tax burden for folks who live in areas of super high increasing property values. It caught my eye because most folks in Gilbert just received their property tax valuations for next year, and were shocked to see the 50-60% increases. One of the problems in cashing in on increased property values is a tax issue. As the WSJ explains:

A growing number of homeowners, riding the crest of the real-estate boom, are getting hit by an unpleasant surprise when they sell: a hefty tax bill.

This development stems from a 1997 law that Treasury Department officials said at the time would eliminate capital-gains taxes for nearly everyone selling their primary residence. Under that law, most married couples who file jointly can exclude as much as $500,000 of their gain. For most singles, the limit is $250,000.

But as home prices have surged, more people have been selling their home for bigger gains than the exclusion amount -- and thus are facing unexpectedly big tax bills, accountants and other tax professionals say. Besides getting hit by the top 15% rate on capital gains, some also are facing the loss of deductions, exemptions and credits. In some cases, they may even be drawn into the rapidly expanding web of the alternative minimum tax.

Many sellers are startled to hear they owe any tax at all because they didn't realize the 1997 law erased a popular provision that had allowed them to avoid taxes. That provision generally allowed sellers to defer or eliminate capital-gains taxes by rolling over their proceeds within a specified time period into a new home costing as much or more than the old one. The law also deleted another provision that generally offered a once-in-a-lifetime $125,000 exclusion for people age 55 or older.

In Morrison Ranch, it is unlikely that any house would garner a $500,000 gain (yet), but there are plenty that have seen more than $250,000; and while this is something to keep an eye on for our residents, there is another more likely tax pitfall, and that is the requirement to live in a house for 2 of the 5 years preceding a sale in order to exclude the gain. There are plenty of exceptions, of course; if you want a little light reading, check out the IRS' publication 523 to get all the gory details. And of course, consult your tax professional (CPAs will have more work than we can handle as long as the tax code remains so complex); it's a better plan to ask her BEFORE you sell than after the deed is done.

Of course, The Mister points out that the increase in value for most of us is pretty much of value only on paper (unless you remove some of your equity through home-equity loans, a tactic that I oppose for general purposes); it's nice to look at, but doesn't mean much in our day to day living.

But one thing that all residents ought to have, whether you plan to sell soon or never, is a ledger of some sort detailing the improvements to your homes. The WSJ agrees:

For anyone thinking about selling, the rules underscore the importance of keeping good records of home-improvement costs, which typically can be added to your original purchase price -- and thus cut, or even eliminate, your tax bill. Examples of improvements include adding a bedroom or bathroom, putting up a new fence, installing new plumbing or wiring, and putting on a new roof. Even the cost of putting in shrubs and trees may qualify as "improvements" and raise your cost basis, according to the Ernst & Young Tax Guide 2006. But the cost of repairs, such as repainting your home or fixing gutters, can't be added to the purchase price of your property, the IRS says.

Go back to publication 523 for more detailed information on what expenses can be added to your basis. It is a great privilege to live in an area with rising property values; it requires some responsible recordkeeping to ensure that you pay only what you owe to the taxman.