Monday, July 18, 2016 / by Teresa DiPeso
There are now only two real tax benefits available to the American homeowner -- interest and real estate tax deductions, and the capital gains exclusion for your principal residence.
In order to qualify for these tax benefits, the home in which you live must be your legal, principal residence. And although interest and tax deductions are also available for investment properties, this column will address only your personal home.
There is no statutory definition for principal residence in the Tax Code. If you ask an IRS agent for a definition, she will have to admit that "whether or not property is used by the taxpayer as his principal residence . . . depends on all the facts and circumstances in each case, including the good faith of the taxpayer."
There have been very few court cases in which this concept has been defined. But in those cases, the courts give the same answer as the IRS: we will investigate the facts of each case, and make our decision based on those specific facts, on a case-by-case basis.
If you have been living in the same home for a number of years, and consider it to be your principal home, there should be no question that it is your "principal residence." Some of the factors to be considered include the address on your driver's license, your voter's registration and where you pay local or state income taxes.
However, if you moved out of your house and have been renting it for some time, you will have to review the specific facts involving your particular situation, to make sure you still qualify for these basic homeowner tax benefits.
In its regulations, the IRS states that "the mere fact that property is, or has been, rented is not determinative that such property is not used by the taxpayer as his principal residence." The IRS volunteers the following illustration: "if the taxpayer purchases his new residence before he sells his old residence, the fact that he temporarily rents out the new residence during the period before he vacates the old residence may not, in light of all of the facts and circumstances of the case, prevent the new residence from being considered as property used by the taxpayer as his principal residence."
The tax courts have also made it very clear that a taxpayer is not required to actually occupy the old residence on the date of sale. The courts -- and the IRS -- will look at the particular facts and circumstances.
However, keep in mind that to take advantage of the new tax saving laws, there are statutory time limits that have to be honored. Under the Taxpayer Relief Act of l997, a married couple filing jointly can exclude up to $500,000 of profit (capital gain) so long as the house has been occupied for an aggregate of at least two of the five years before the house is sold. An unmarried individual (or a person filing a separate tax return) can exclude up to $250,000 of gain. Neither the IRS nor the courts have the authority to extend this time.
If you meet the statutory time restrictions, we then look to the facts involved in each case. The courts -- and the IRS -- carefully analyze the intent of the taxpayers. Did they, for example, truly intend to sell their house, but were unable to so because of market conditions? Or was their real motive merely to keep the old house as investment property?
The burden of proof is on the taxpayer. You must be able to demonstrate that you did not intend to abandon your house as a principal residence.
It should be noted that there are times when a homeowner wants to have the house considered as "investment" rather than principal residence. For example, if you have made a significant profit (i.e. over $500,000) and are faced with a sizable capital gains tax, you may want to consider doing an exchange under Section 1031 of the Internal Revenue Code. Keep in mind that you can only exchange investment properties, not principal residences.
If you want to preserve your home as your principal residence, what should you do?
First, it is advisable to try to sell your house before you rent it. According to some tax court cases, evidence of attempts to sell property have been a significant factor when ruling on this question.
Second, avoid any impressions that you are not abandoning your old house as your principal residence. . Periodically discuss the possible sale of your property with real estate professionals and keep records of those conversations.
Third, if you have purchased a new house, until you sell the other one, try to keep your old house as your principal residence. For example, have you changed your drivers license? Have you changed your voting registration? In which jurisdiction do you pay taxes? Have you told anyone you no longer wish to return to your old house?
All of these factors will play a role in determining the facts and circumstances of your particular case.
There is an old adage that your home is your castle. Whether it will also be your principal residence will depend on how carefully you have preserved and documented all of the relevant facts.
Politics will continue to play heavily on the future determination of all real estate tax deductions. However, the American homeowner is a strong lobby, and it doubtful that Congress will ever repeal the great American dream of homeownership. At best, it may "tinker around the sides" by -- for example --putting dollar limitations, above which you either lose the deduction or it is phased out depending on the facts.
By Benny L. Kass