Q:

Subject: Sale of Primary Residence

 

Kerry,

A friend and his wife bought a house in foreclosure and remodeled it themselves.  As a result, they are sitting on a substantial unrealized gain.

His wife is pregnant and they would like to sell their house due to the pregnancy, but they have not lived in it for 2 years.  Does the pregnancy count as an “unforeseen circumstances” for getting the pro-rated gain exclusion?  It was, in fact, unplanned.  I reviewed your site and the IRS site, and the only thing I found regarding pregnancy referred to multiple births from the same pregnancy, so I am not sure if this disqualifies a single birth from the exclusion.  Thank you for your help.

A:

Following is a quote from the IRS publication 523 on home sales in regard to the application of the pro-rated tax free exclusion:

The suitability of your property as a home materially changed,

If the home was originally purchased for the benefit of a certain sized family, and the family has grown to the point that the home is no longer able to handle the capacity, that is a valid reason to force you to sell before the full two years are up.

Based on how you explained your situation, you should qualify for the pro-rated tax free exclusion.  Your personal tax advisor should be able to help you with more specifics, such as the size of your actual gain.

Good luck with your new baby and the upcoming move.

Kerry Kerstetter

Follow-Up Q:

Kerry,

Thank you for the speedy reply.  Even if the house would still reasonably fit a family of 3?  Would the IRS argue that a 3-bedroom house is able to handle the capacity so the exclusion does not apply?

Thanks again for your help.

A:

As in all tax matters, the burden of proving that you are doing things properly rests with you.

You made the claim that the move to a bigger house was due to the impending birth.  You should feel strongly enough about that rationale to be able to convince IRS in the unlikely chance of a challenge. 

The number of bedrooms your house has isn’t the issue, depending on how you are using them.  For example, my wife and I live in a house with four bedrooms. However, two are fully used as offices and one is used for storage and computer servers.  If we needed space for more people, as we may soon need with some of Sherry’s relatives who have been displaced by the New Orleans hurricane, we would need to find new space for them. 

If the three bedrooms you currently have don’t allow space for the new baby, a move to a new home seems like the logical thing to do.

Again, check with your personal tax advisor for more specifics on your situation.

Kerry Kerstetter

 

Q:

Subject: Selling my home question

I read a recent article of yours relating to getting a $250 per person exclusion when selling your home. That was very informative, but I have an additional question. My wife died a couple of months ago. Can I claim two deductions if I sell my home in the same year that she passed away? I will be making more than $250K profit on my home and this might influence my decision to sell now or next year.

Thanks,

*** in PA

A:

 I’m sorry to hear of your loss. 

You do really need to be working one on one with a tax pro.  That is never a more important consideration than after a major life changing event such as you are going through.

To specifically apply the residence sale rules to your situation, there is a very big twist.  Essentially, there is no need to claim both of the $250,000 exclusions because your wife’s half of the profit has already been wiped out.  When a person passes away, her heirs receive most of her assets at what is called a stepped up basis, which is the item’s fair market value at the time of the person’s death.  This means that all of the profits that had accumulated during her lifetime have literally been wiped off the books. 

What this means for you as the surviving spouse is that your personal cost basis in the home is now made up your half of the original basis (which is normally what you paid for it plus capital improvements) plus the new stepped up basis for the other half.  If you sell the home, that is what you would be using in the calculation of your profit.  You could then exclude up to $250,000 of profit on your 1040, assuming that you have been living there at least two out of the previous five years.  That exclusion amount would be prorated if  you have lived there less than two years.

Because PA is not a community property state, you only receive a stepped up basis on half of the home.  Surviving spouses in community property states actually have the total basis of their homes stepped up, effectively wiping out all of the accumulated capital gain.

Some assets don’t have this new stepped up basis.  For example, most often pre-tax retirement accounts are still going to be subject to tax when you make withdrawals.  This is another reason why you absolutely must be working with a tax pro who can properly advise you on all of the tax twists that are now part of your world.

Good luck.

Kerry Kerstetter

 

I’ve written a lot on the issue of donating vehicles to charities and the abuses by people claiming much higher values than they would actually sell for.  As a result, our rulers in DC passed a law late last year limiting the deduction to whatever amount the charity was able to sell it for.  This law took effect as of January 1, 2005. 

In typical fashion, IRS has come out with a new form (1098–C) for the charities to fill out documenting the donations and sales amounts.  You can download pdf versions of  the 2005 Form 1098–C and its instructions from the IRS website.

Effective as of October 1, 2005, the rates they charge will go up by a full percentage point, to 7.0%.

I have updated my Quick Reference page accordingly.

Q:

Subject: Audit Question

Dear Tax Guru,

My husband is being audited for his 2003 return. He finished his MBA in May 2003, began working in September 2003 and deducted his last semester of tuition fees when he filed his return. Apparently a tax expert gave a seminar in school explaining why MBA students can make this deduction, but maybe he was mistaken. Anyway, my husband is not working in the same field or for the same company that he left when he took time off to go for his MBA. Do you think there is any justification he can use for claiming this deduction?

Thanks in advance for your help,

A:

It sounds as if your husband misinterpreted the rules for deducting education costs.  As long as I’ve been in the tax business (over 30 years), this has been one of the craziest Catch 22 type rules.  Basically, you are only allowed to deduct education costs related to the profession you are already in.  Education costs incurred to enter new professions have never been deductible. 

I’ve always thought this law to be counter-productive in regard to the country’s work-force, which should be encouraged to learn the skills necessary to adapt to the changing business environment, such as factory workers learning how to use computers.  Unfortunately, the words “Logic” and “Congress” are as incompatible as any two words could be.

It doesn’t look good for your husband in regard to salvaging this deduction.  He will owe the extra tax plus interest.  However, the penalties that auditors routinely toss in are completely negotiable and can be waived if your husband can convince the auditor that this was an accidental misinterpretation of the law.  If he hasn’t already done so, he should also make sure he has deducted all of his job hunting costs.

Another lesson that you both should take from this is the wisdom of using a professional tax preparer instead of trying to interpret the laws and regulations on your own. 

Good luck.

Kerry Kerstetter

Update:

Employee Could Deduct Cost of MBA That Helped Him Move Ahead in Company

New rules for alternative vehicle purchases, leases

IRS S corporation audit plan draws mixed reviews

 Letting go of business – Succession planning.

Judge to tell IRS to reopen collection bids – Others, such as the Soprano and Gotti families, are anxious to get the contracts to use their special skills to collect money for the IRS.

TIGTA finds IRS is lax in combating identity theft – Not good, especially considering how much of our vital info IRS has in its possession.