- The Washington Times - Wednesday, June 18, 2003

Q: I read your recent column about new tax laws and their benefits. It was great information, and I

appreciate your sharing it. I have owned a condo since Dec. 21, 2001. I am getting married, and I want to sell the condo. If I sell the condo before Dec. 21, 2003, will my gains penalty still be 28 percent, or will it be dropped to a lower rate?

A: The capital gains on real estate are tax free for most homeowners around the country. If any tax could be considered a tax on the rich, the capital gains on real estate profits would fall in that category — at least for gains on the sale of your primary residence.

Generally, the average homeowner will never pay capital gains taxes on proceeds from the sale of his home. When you consider that the national average price of a home lingers at about $160,000, the average homeowner won’t even receive enough gains to tax. A single filer doesn’t owe capital gains taxes on the sale of real estate until the gains exceed $250,000. For married filers, the floor is $500,000.

The criteria for walking away with this lottery of sorts is twofold: the floor amount of gain —$250,000/$500,000 — and whether you have lived in the property at least two of the past five years.

Unless you live in an amazingly luxurious unit, I don’t see how you will gain $250,000 on your condo. Keep in mind, the cost of purchasing the house (referred to as “basis”) is subtracted from your gross gains to arrive at your gain. For example, if you purchased the condo for $200,000 and sold it for $300,000, the basis would be $200,000 (plus points paid, closing cost, etc.). To keep it simple, let’s just say it’s $200,000. Your gross receipts are $300,000 — subtract your loan amount (let’s say you’re down to $150,000) and your gain is now at $150,000. Because you haven’t reached the floor of $250,000 as a single filer, you owe no taxes on the capital gain.

Now, your first reaction may be guilt. “Wait a minute, I can walk away with $150,000 tax free?” you might ask. Yep. That’s the way it is.

The thought of your selling your condo and moving into another home with your new husband has me wondering why you aren’t holding onto the condo as a rental property. Real estate is a very good investment, and you get a lot of deductions from a rental that you don’t get from a primary residence. Plus, the renter would be paying the mortgage, etc., and the property could appreciate year after year, creating a nice little nest egg. Once the condo is paid off, you also would have substantial passive income.

Here’s the financial scenario: You pay your mortgage now and all you get for a deduction is the interest payment and property taxes, assuming you don’t use one of the rooms as a home office — but that’s another question.

For rental properties, you deduct all the interest, property taxes, condo fees and expenses for upkeep; plus, for a simple rental property, you get to depreciate it, as well, and this contributes to reducing your tax bill. If you actively participate in the operation of the rental property — in other words, manage it by screening potential renters, calling in workmen for repairs and the like — you can deduct a limited amount of any losses from the rental activity from your annual income.

I have seen some investors end up having “losses” from their rental income and end up deducting that loss from their regular income. The depreciation alone can put you in the negative without actually depleting your cash flow.

For all the ins and outs of deductions available to rental-property deductions, seek out Publication 527, “Residential Rental Property (Including Rental of Vacation Homes)” at www.irs.gov.

You might wonder, “Well, just how much can I deduct?” Here’s the section on limits on losses from page 15 of Publication 527 under the section titled “Losses From Rental Real Estate Activities”: “If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.”

Bottom line: Hanging onto that rental property can save you tax dollars and get you and your new hubby on the road to creating wealth.

M. Anthony Carr has written about the real estate industry for more than 15 years. Reach him by e-mail ([email protected]).

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