Cost basis when selling a house

[donheff]

An ongoing thread on tracking the cost basis of investments got me thinking about my two houses. DW and I hope to die in our primary residence so it will simply get upgraded to market value at the time, easy peasy for our heirs I hope. But there is a good chance that we will sell our weekend place in ten years or so and will have to pay capital gains. How detailed does IRS demand the records to be? We have solid info on the initial land purchase and the home loan to build the place and build a pool. But the documents on some upgrades (landscapping, rip rap) are sketchy. Also, the original rip-rap (erosion protection) was faulty and I had a talented friend redo it. Is that maintenance or an upgrade. His documentation was even more sketchy. He also replaced all of our windows (also a faulty original choice) - maintenance or upgrade?

So what is the verdict? Just make a good faith estimate and pay the taxes you think are fair? Go very conservative with only what you can prove? How does IRS treat sketchy cost documentation?

 

[panacea]

My understanding with anything IRS is that you must make a good faith estimate for anything that cannot be documented with precision.

 

[RE2Boys]

What "panacea" said. Difference in maintenance vs capital improvement is sometimes one of degree. Full replacement of windows is a capital improvement. Full re-build/replacement of rip-rap would also be a capital improvement.

 

[MichaelB]

The IRS has a short list of improvements about a third of the way down this link Publication 523 (2012), Selling Your Home . Typically, if it stays with the house it is part of the cost. When we sold my sense was the IRS was pretty soft on documentation and reporting, don't expect much has changed. Also agree with panacea on good faith / best effort.

 

[ERD50]

I'm also curious about this too - some people here must have some real life experiences with this?

I have a big box of papers, and very little in the way of organization. It's something I have procrastinated on, as it sure doesn't look like much fun. I've done a LOT of upgrades, mostly DIY, a few big ones were contracted.

As I understand it, I need to go back all the way to my first home purchase in 1977, as I rolled one house to another (3 total).

I know I should at least put a spreadsheet together with the basic, large costs, and slip a copy in the safe deposit box. Then go back and fill in details as I work on them, hitting the big ones first. But I could add every light fixture upgrade, faucet upgrade, etc - that's a huge list, but it would add up. If I were to pass and DW sell the house, she would be faced with this. I really should get these ducks in a row. Hopefully, this thread will help push me to get it done.


-ERD50

 

[MichaelB]

I'm also curious about this too - some people here must have some real life experiences with this?

I have a big box of papers, and very little in the way of organization. It's something I have procrastinated on, as it sure doesn't look like much fun. I've done a LOT of upgrades, mostly DIY, a few big ones were contracted.

As I understand it, I need to go back all the way to my first home purchase in 1977, as I rolled one house to another (3 total).

I know I should at least put a spreadsheet together with the basic, large costs, and slip a copy in the safe deposit box. Then go back and fill in details as I work on them, hitting the big ones first. But I could add every light fixture upgrade, faucet upgrade, etc - that's a huge list, but it would add up. If I were to pass and DW sell the house, she would be faced with this. I really should get these ducks in a row. Hopefully, this thread will help push me to get it done.


-ERD50

The rolling of previous homes doesn't matter. Just the purchase price, including fees, of the house you sell, and all the improvements. If this is the primary residence and a joint ownership, the first $500K "profit" is exempt from tax.

 

[ERD50]

The rolling of previous homes doesn't matter. Just the purchase price, including fees, of the house you sell, and all the improvements. If this is the primary residence and a joint ownership, the first $500K "profit" is exempt from tax.

If I'm reading this right (and I'm not good with IRS-ese), the IRS disagrees (my first two homes were sold prior to 1997):

Publication 523 (2012), Selling Your Home

Recordkeeping. You should keep records to prove your home's adjusted basis. Ordinarily, you must keep records for 3 years after the due date for filing your return for the tax year in which you sold your home. But if you sold a home before May 7, 1997, and postponed tax on any gain, the basis of that home affects the basis of the new home you bought. Keep records proving the basis of both homes as long as they are needed for tax purposes.

So for me, the $500,000 exclusion goes back to my lifetime real estate gains (up to this current house).

But this research has been helpful. Bottom line for me is, unless home prices here go crazy, I am unlikely to exceed a combined $500K gain, and I've got a handful of large improvements that would reduce that gain with minimal effort/record-keeping on my part. So I should make sure the big expenses are documented, and keeping a big box of the little expenses is probably fine as I will probably never need them.

IIRC, the 1997 thing goes back to a time when there were no cap gains if you bought a new house of equal/greater value (I guess it was treated like a 'like kind' exchange'?), you didn;t realize the gain until the 'final' sale. So now, you pay on any gain over the exclusion (assuming you meet residency time requirements) each time you sell. So they had to 'capture' that previous to 1997 gain to make it work going forward.

edit/add: One of my big expenses was an addition on a previous home in the late 80's. So I need to keep those records, which are already ~ 25 years old. I really wish the IRS would force you to record these in the year they occurred, and just carry the number forward on your tax forms each year. This would avoid going back decades. Of course, I'd rather see cap gains excluded from income altogether, but that's another story....

-ERD50

 

[ChiliPepr]

Donheff... if you are going to sell your "weekend" place and that place will have a significant gain, I would try to make that your "principal" place for a couple years before you sell. Not sure how far apart they are, but if you could do that, you would be able take the tax exclusion on that sale and then move back into your other home.

 

[ChiliPepr]

If I'm reading this right (and I'm not good with IRS-ese), the IRS disagrees (my first two homes were sold prior to 1997):

Publication 523 (2012), Selling Your Home



So for me, the $500,000 exclusion goes back to my lifetime real estate gains (up to this current house).

I believe that is only until you sell your first house after 1997. You are correct if you are living in a house you purchased pre 1997 and you rolled profit into this house.

 

[ERD50]

I believe that is only until you sell your first house after 1997. You are correct if you are living in a house you purchased pre 1997 and you rolled profit into this house.

That is my situation. First home purchased in 1977, sold 1st and bought 2nd home in 1981, sold 2nd and bought 3rd home in 1992 - still own this third home. All primary residences.

So as I understand it, if I sell this home, my cost basis goes back to 1977, and we get a $500,000 exclusion against any gains. Capital improvements and allowed expenses on any of these homes will reduce my gains.

If I were to then buy a new home, I think that new home also has another $500,000 exclusion if I meet residency requirements.

-ERD50

 

[MichaelB]

If I'm reading this right (and I'm not good with IRS-ese), the IRS disagrees (my first two homes were sold prior to 1997)

-ERD50

You're correct. Something new learned today. Another lesson inhow easy it is to give bad advice.

An ongoing thread on tracking the cost basis of investments got me thinking about my two houses. DW and I hope to die in our primary residence so it will simply get upgraded to market value at the time, easy peasy for our heirs I hope. But there is a good chance that we will sell our weekend place in ten years or so and will have to pay capital gains. How detailed does IRS demand the records to be? We have solid info on the initial land purchase and the home loan to build the place and build a pool. But the documents on some upgrades (landscapping, rip rap) are sketchy. Also, the original rip-rap (erosion protection) was faulty and I had a talented friend redo it. Is that maintenance or an upgrade. His documentation was even more sketchy. He also replaced all of our windows (also a faulty original choice) - maintenance or upgrade?

So what is the verdict? Just make a good faith estimate and pay the taxes you think are fair? Go very conservative with only what you can prove? How does IRS treat sketchy cost documentation?

If you make the second home your primary residence for two years it is then eligible for the $500K exclusion.

 

[JoeWras]

The rolling of previous homes doesn't matter. Just the purchase price, including fees, of the house you sell, and all the improvements. If this is the primary residence and a joint ownership, the first $500K "profit" is exempt from tax.

My dear deceased mom toiled endlessly on keeping records of every tiny improvement (new toilet, for example).

Now that we're selling the house for Dad, it doesn't matter. The gain even without improvements is less than 15k. It will be exempt.

Probably will be the same case for my house, unless inflation really catches fire in the next 20 years or our neighborhood becomes some trendy place. Just in case, I've kept records of the big improvements (we have 3 that are in the 5 to 10k range).

 

[donheff]

Donheff... if you are going to sell your "weekend" place and that place will have a significant gain, I would try to make that your "principal" place for a couple years before you sell. Not sure how far apart they are, but if you could do that, you would be able take the tax exclusion on that sale and then move back into your other home.

I am aware of that. I wouldn't want to move there full time for two years and trying to stretch the truth would be difficult. While I believe in stretching things as far as I can (the straight face test) DC is about as tough as California about getting their tax dollars.

 

[MichaelB]

I am aware of that. I wouldn't want to move there full time for two years and trying to stretch the truth would be difficult. While I believe in stretching things as far as I can (the straight face test) DC is about as tough as California about getting their tax dollars.

You don't have to be there full time. It just needs to be the primary residence for 2 years, you can still spend half the time elsewhere.

 

[Cessna5354]

I believe those two "primary residence" years, must be two years with in the last five years.

Hence, it need not be the immediate preceding years.

 

[harley]

I thought they changed the rules about primary residence/second home situations a few yeaars ago. If I recall correctly, now the CG exclusion is based on the percentage of the time the home was your primary residence. For example, my second home is soon going to become my primary, but say I sold 10 years after I make the change (15 years total ownership). According to what I think is the case, I'd only be able to claim 66% of the exemption when I sell.

Of course, this is all from memory. When I get back from the music festival tonight I'll try to do some research and see if I'm just blowin' smoke.

 

[sengsational]

That is my situation. First home purchased in 1977, sold 1st and bought 2nd home in 1981, sold 2nd and bought 3rd home in 1992 - still own this third home. All primary residences.

So as I understand it, if I sell this home, my cost basis goes back to 1977, and we get a $500,000 exclusion against any gains. Capital improvements and allowed expenses on any of these homes will reduce my gains.

Unbelievable how the IRS expects you to keep records for 50 years while inflation keeps making those dollars more and more worthless.

Although I bought a primary residence in 1987 and got another primary residence in 1996, there's no way I'm going to make 500K on this shack!

I did utilize the "2 years in the past 5" rule on the 1987 place because it was a rental for a few years before I sold it. It will be interesting to hear what the post music festival research indicates.

 

[JOHNNIE36]

That is my situation. First home purchased in 1977, sold 1st and bought 2nd home in 1981, sold 2nd and bought 3rd home in 1992 - still own this third home. All primary residences.

So as I understand it, if I sell this home, my cost basis goes back to 1977, and we get a $500,000 exclusion against any gains. Capital improvements and allowed expenses on any of these homes will reduce my gains.

If I were to then buy a new home, I think that new home also has another $500,000 exclusion if I meet residency requirements.

-ERD50

Something doesn't ring true here. I don't think your cost basis goes all the way back to 1977. I would think house #1 that sold in 1981 is handled on it's own merits. IOW, if you didn't owe any taxes on house #1, then it's over and done and you start again in 1981. House #2 is sold in 1992 and any tax owed is paid then. You start over again with this house. If you make over $500k on the sale of this house (as a couple), taxes would be due. Now you want to know the cost basis of that house. It would have nothing to do with what you did in 1977.

Maybe someone else can clarify this.

 

[meierlde]

Note that if the sales proceeds are under 250k the IRS does not recieve any notification, and you no longer need to tell them anything. One of the forms at closing has this as an option if the proceeds are less than 250k. So if in the middle of the country in many cases record keeping is not needed since you will be under the limit (In Indianpolis for example the median home is less that 170k) now on the coasts the answer is different. The median is about the same in Houston BTW.

 

[calmloki]

bE ADVISED: hARLEY IS CORRECT.

See IRS pub 523, worksheet two, especially lines 8-12. In fact DonHeff, pub 523 should become your light reading for a while. Big changes took place in 2009. dammit. No more the landlord two year hop for tax free gain. dammit.

 

[ERD50]

bE ADVISED: hARLEY IS CORRECT.

See IRS pub 523, worksheet two, especially lines 8-12. In fact DonHeff, pub 523 should become your light reading for a while. Big changes took place in 2009. dammit. No more the landlord two year hop for tax free gain. dammit.

I thought he would be right. It just didn't make sense to me that living there a couple years would 'reclaim' the years that you didn't live there. But putting 'taxes' and 'making sense' in the same thought is not a good guide, might even be a contrary indicator

Something doesn't ring true here. I don't think your cost basis goes all the way back to 1977. I would think house #1 that sold in 1981 is handled on it's own merits. IOW, if you didn't owe any taxes on house #1, then it's over and done and you start again in 1981. House #2 is sold in 1992 and any tax owed is paid then. You start over again with this house. If you make over $500k on the sale of this house (as a couple), taxes would be due. Now you want to know the cost basis of that house. It would have nothing to do with what you did in 1977.

Maybe someone else can clarify this.

I'll be interested to hear from others also to confirm or correct, but I do believe this is how it works. It's not that I 'didn't owe taxes' on the first two houses ( I had a gain), it is more like those taxes were deferred, and rolled up into the next house, to be collected when you sell, but do not re-purchase a home of equal or greater value. That is when the taxes came due. And then it changed in 1997, but you still need to capture that gain from the prior time frame, if it wasn't captured then.

This is maybe not technically correct, but it looks to me that they structured it as a 'like-kind exchange' transfer, but for home-owners rather than businesses. Here, wiki says it better than I can:

A like-kind exchange under United States tax law is a transaction or series of transactions that allows for the disposal of an asset and the acquisition of another replacement asset without generating a current tax liability from the sale of the first asset. A like-kind exchange can involve the exchange of one business for another business, one real estate investment property for another real estate investment property, livestock for qualifying livestock, and exchanges of other qualifying assets.

-ERD50

 

[donheff]

Thanks for the reference. IRS Pub 523 appears quite comprehensive. But it doesn't look like anything new to me. I can still live in the VA home for two out of the five years preceding sale and claim it as my main home thus garnering up to the whole $500K exclusion from CGs. My problem is living there. I like to go down every other weekend or so and for some more extended periods but I don't want to stay there most of the time. I do want to include as much as possible in my cost basis when (and if) I sell. The publication is helpful on that topic.

 

[calmloki]

Thanks for the reference. IRS Pub 523 appears quite comprehensive. But it doesn't look like anything new to me. I can still live in the VA home for two out of the five years preceding sale and claim it as my main home thus garnering up to the whole $500K exclusion from CGs. My problem is living there. I like to go down every other weekend or so and for some more extended periods but I don't want to stay there most of the time. I do want to include as much as possible in my cost basis when (and if) I sell. The publication is helpful on that topic.

Again, reference lines 8-12 of worksheet two. You get to shelter a fraction of your gain. Plainly put, if you bought on 1/1/2009 for $100k, lived there for two years, and sold 1/1/2014 for $200k ($100k profit) you could shelter $40k and pay tax on $60K. Try plugging the above numbers into the worksheet and check me.

 

[donheff]

Again, reference lines 8-12 of worksheet two. You get to shelter a fraction of your gain. Plainly put, if you bought on 1/1/2009 for $100k, lived there for two years, and sold 1/1/2014 for $200k ($100k profit) you could shelter $40k and pay tax on $60K. Try plugging the above numbers into the worksheet and check me.

Thanks Camloki, I see. looks like I couldn't get much of a break by moving in for two years. Even if I did it today, by the time I sold in 2 years I would only get something like 1/3 of the max (2 out of 6 years going back to 2009). If I sold in ten years that would drop to something like 1/7. I thought maybe something was wrong since the worksheet didn't seem to fit in with the maximum exclusion part in the body of the publication but I Googled the issue and found this easy to understand description on nolo.com:

Reduced Exclusion for Second Home Also Used as Primary Home

As of January 2009, new tax rules require that, if you sell a home that you sometimes used as a vacation or rental property and sometimes as your primary residence, you're eligible for only that portion of the capital gains exclusion that corresponds to the amount of time you actually lived there as your primary residence. (The rest of the time is called "non-qualifying use.") Note that the calculation is made over more than a mere five-year period -- it applies right back to January of 2009. What's more, if, during the five years before the sale, you never actually made the home your primary residence, you're likely disqualified from using the exclusion. (You won't be surprised to hear that this new rule was meant to generate additional tax revenue, to offset some other tax cuts.)

 

[haha]

Note that if the sales proceeds are under 250k the IRS does not recieve any notification, and you no longer need to tell them anything. One of the forms at closing has this as an option if the proceeds are less than 250k. So if in the middle of the country in many cases record keeping is not needed since you will be under the limit (In Indianpolis for example the median home is less that 170k) now on the coasts the answer is different. The median is about the same in Houston BTW.

Please, could you give a reference for this?

Ha