A caller to our radio program asked a question that usually surfaces when a person is considering the purchase of a second home.
“Why are we able to deduct the mortgage interest on two homes rather than just one?
The reason why taxpayers are able to reap the advantages of having two homes can be directly traced to our members of the U.S. House of Representatives and Senate. Congressional members “needed” two homes – one in their home state and another in the nation’s capital. (Some accountants even refer to the curious guideline as the “Congressmen's Rule”).
When members of Congress approved the Taxpayer Relief Act of 1997 nearly 18 years ago, they completely overhauled and multiplied the possibilities for second-home purchase, use, and sale.
When you couple the ability to own two (or more) personal residences simultaneously, then toss in the capacity to convert a rental property into a personal residence, you might be overwhelmed to discover the windfall profits brought by simple combinations of appreciation and tax savings. Let’s examine examples that are applicable to traditional age brackets and investment phases.
Before we do, take a moment to state aloud: “Moving into my rental property is not a taxable event.” And, then remember you can can sell my primary residence every two years and pay no tax if the gain is limited to $500,000 for married couples, $250,000 for single persons.
As most taxpayers know by now, the 1997 tax legislation added a generous exclusion for sales of primary residences. If you own one or more residences, there are some tax-saving chess moves to be made – all above board – but preparation and timing are always important. The basic gain exclusion qualification rule is simple: You must have owned and used the home as your main residence for at least two years out of the five-year period ending on the date of sale. If you are married, the full $500,000 capital gains break ($250,000 for singles) is available as long as one or both of you satisfies the residency and ownership guidelines.
Let’s say Robert Moviestar and his wife, Gloria, are married and own three homes. First there's their current main home, not far from the movie studio in Hollywood where Robert works, which qualifies for the $500,000 capital gains exclusion. They paid $550,000 for the place, sell it for a net of $950,000 and put $400,000 of gain in their pocket because it is less than the $500,000 maximum exclusion.
Robert and Gloria then move to their Santa Fe, New Mexico, vacation home where Gloria shows her artwork. After living in Santa Fe for two years, Robert and Gloria sell the home, pocket $475,000 (their net again was less than the maximum ($500,000) of tax-free gain and move to Orlando, Florida, where Robert can take a bus to sign autographs with Mickey at Disney World. After living in Orlando for two years, Robert and Gloria can sell, pocket up to $500,000 in gain tax free, move again . . . the tax-free carousel continues and the gain goes in their pockets.
Here’s another example for people who work in two different locations. Sally Long, 37, a single dentist, has a residence in both areas where she has an office – Seattle and Gig Harbor. Both properties have significantly appreciated in value over the past decade. Sally sells her principal residence in Seattle, takes her capital gain exclusion of up to $250,000 on that residence, and decides to move into the Gig Harbor home. Gig Harbor now becomes her principal residence. Sally lives there for two years and thereby satisfies occupancy test. Sally then decides to retire. She sells the property and realizes another big-time gain, of which $250,000 can be excluded, and moves to the San Juan Islands.
You’re right – few people want the hassle of moving to a new primary residence every two years. But you could, and the vacation home, or homes, you own now could be involved, tax-free. If you permanently convert or temporarily flip-flop the status of rental properties to personal residences, more moneymaking possibilities quickly surface.
New book: Follow real estate agent and basketball coach Ernie Creekmore as he attempts to solve another murder – this time a “helicopter” parent constantly prodding his star athlete son. Tom Kelly’s “Hovering Above a Homicide” is now in print and Ebook form. Get a signed copy at TomKelly.com or purchase at bookstores everywhere and online.
As author, nationally syndicated newspaper columnist and talk-show host, Tom Kelly has carved a niche as one of the leading real estate and finance journalists. His book “Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border” was written with Mitch Creekmore, senior vice president of Stewart International, and is available in retail stores and on Amazon.com. He and his wife, Jodi, Dean of the Humanities College at Seattle University live on Bainbridge Island, WA. Their four grown children are spread out around the world and their first grandchild, Myles Thomas, makes them goofy with joy. You can connect with Tom on his Facebook page at https://www.facebook.com/tom.kelly.37604303, or check out his website at http://tomkelly.com.
Tom Kelly’s novel “Cold Crossover” is now available in print at bookstores everywhere and in both print and Ebook form from a variety of digital outlets. Follow real estate agent and former basketball coach Ernie Creekmore as investigates the disappearance of his star player on a late-night boat. Check out the national reviews and put “Cold Crossover” on your list.