Real Estate Article: So I sold my house, but is it tax free?
02/11/2005
Real Estate Article: So I sold my house, but is it tax free?
02/11/2005
Under what circumstances the gains are tax free?
Many, many sellers ask me question before. I am not an accountant, nor an IRS officer, therefore in the past I always tell my clients to consult with an accountant. 
However, most sellers will probably tell you that they were even more baffled after they consult with their tax professionals. This is due to the way the law was written and interpreted. As an IRS agent or a judge will tell you—it will depend on all the facts and circumstances on the individual cases. Lack of clear explanations on this tax law for the last 6 years had resulted in more homeowners challenging the IRS to clarify. Finally, after 6-long-confusing years for CA homeowners, the IRS finally provided some sets of explanation that will help us understand the law at least to some deeper extent than ever before.
At the first glance, this 1997 tax law appear to be pretty simple enough--if you have owned, and used a real estate as your principal residence for at least two years during the five year period ending on the date that property is sold, you may exclude your capital gains up to $250,000 if you are single or $500,000 if you are married and file a joint tax return.
This law became effective for 6 years, and for five years, homeowners and tax attorneys and other tax practitioners has been in the dark as to questions like the statuary definition of principal residence, the exclusion of the “unforeseen” circumstances, and a new regulation which provided a chance for homeowners to amend a tax return if he or she qualifies.
The very task is to define the very term “principal residence.” Generally, if you have lived and owned the same home for more than two years and you own only one house, then that house is without a doubt your principal home. If you own a house and it is constantly on rent or you own a beach house and you go there for vacation three months a year, those will not be considered your principal residence.
To the IRS, an honest tax payer should know which property is your own principal residence. In case an IRS agent decided to audit your case, you will be responsible to provide the necessary documents to prove it—for instance, your billing address, your voter registration address, your car and license registration address, and your tax returns.
If you have two houses, you have the right to choose to live in either one of the properties as your principal residence. Let say that in five years, you lived in your house in Chino Hills for two years, and then at least two whole years too at another house in Diamond Bar, then at this time, either house you sell will be tax free.
There are exceptions to the two-year rules, however. They are called the “unforeseen circumstances.” If you found a new job and the new job is 50 miles or more away from your original home, or you have to move away due to major health reasons (not general health issue), or you got laid off or your work situation changed that is causing you unable to make the mortgage payment, or a co-owner or a family member died, or a your property was destroyed due the act of war or terrorism…these uncontrollable reasons are considered safe harbors for homeowners to sell their homes within two years and still get at least partial deductions.
These new guidelines came out more than six years of the tax law first taken into effect. Therefore, this year, the IRS also announced that if in the last six years you have sold your properties and paid the full taxes on the gain, but you believe that you are entitled to some or full deduction, you may file 1040X to amend a review on your case and get your return.
What is the new CA tax withholding law?
Effective January 1, 2003, AB2065 require a withholding of 3.33% of the sale price from any individual selling real property in California, regardless of whether
the seller is a California resident, unless an exemption applies.
This law had made many California buyers’ jaws drop—imagine if you sell your house for $1,000,000. The government will withhold 3.33%, meaning $33,300 automatically, even if you only made a profit of $1. Even though by next year you won’t have to pay so much income tax and you can get a return if you don’t make that much money, but to buyers who made little profit, it is hard to have that much money frozen for a year. Unfortunately, there is not much we can do right now, since the law is the law unless in the future enough sellers can gather and voice enough influences to change it.
In the mean time, we will look at the exemptions that exclude sellers from the withholding:
In other words, if you are selling your house at a loss, then you don’t have to pay the withholding; if your selling price is under $100,000, then you won’t have to pay the withholding. You are also exempted if you are selling your principal home. If you are selling a beach house of some sort that can not be considered your principal home, then you will have to pay the 3.33% withholding. If you don’t apply for the exemption and you didn’t pay the withholding, the state of California will fine the seller $1000 or more, up to 20% of the sale price.
In closing, I have to stress that I an m not a tax professional and this article is a merely collective knowledge based on my research to provide you some insight into new policies in California. If you have any tax or legal questions, please always consult with a tax attorney.
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