John Bullis: ‘Sweat equity’ and family changes generate taxable income exclusions
February 12, 2013
The present income tax rules on sale of your principal personal residence are favorable. If you occupied and owned a home for at least two of the five years before sale, the gain (profit) is excluded from taxable income, subject to some limits.
For a single person, up to $250,000 of the gain can be excluded from income (and from self-employment, FICA and Medicare taxes). For a joint return, up to $500,000 of gain is not taxable.
It can be done over and over. If you bought a home and, while living in it for a little more than two years, fixed it up and sold it, the exclusion applies. Then you can do it again and again, every few years.
“Sweat equity” from landscaping, painting, remodeling, fix-ups and other improvements you make is tax-favored. It is not income (not wages) and usually will increase the home’s value. When the home is sold just over two years later, you get the gain exclusion that saves income taxes. It also is important that you do not have the “payroll taxes” that would have been paid if you earned income (wages).
A special rule for a married couple is when one of them dies. The survivor has two years after the death to sell the home and still get the $500,000 gain exclusion.
Yes, home values have been greatly reduced. But what if you bought the home 10 or 15 years ago? The purchase price plus the cost of improvements might still be less than current market values. For tax purposes, the sale might still result in a gain for income tax purposes.
There are special rules on just what “occupancy” is. Short-term absences for vacations and medical care do not reduce the time of occupancy.
Ownership rules include the time of marriage to someone else. The divorce might give the home to the spouse who did not buy it, but the ownership requirement is met because the time a former spouse owned the property counts toward meeting the rule.
Then the rule on “unforeseen circumstances” such as employment changes resulting in a sale because of a move; death; divorce; natural disasters and other things might mean the two-year use and occupancy rules are treated as met. There are several situations that have been found to be “unforeseen circumstances.” In one case a single parent with four children married a woman who had three children. Neither of their existing homes had been owned for two years, and neither home could handle the new family with seven children. Both sold their old homes, and the gains were excluded even though the two-year rules had not been met. They had to go to court to get that favorable ruling, and now the IRS agrees their marriage was an unforeseen circumstance.
Did you hear? “You’re not finished when you’re defeated. You’re finished when you quit.”
• John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs, LLC.