How Katrina may help a real estate seller avoid capital gains tax
Q: I bought 12 acres of land in 1994 for $25,000. Since then, I made maybe $2,000 worth of improvements. Recent hurricanes in the area downed many trees, which I feel have hurt the value of my property. The potential expense of clearing the trees weighed heavily in my decision to sell the property for $135,000 a few months ago. I do not feel I have enough time - 180 days - to find and purchase a similar investment property to defer my capital gain. Are there any strategies I can use to lower or defer taxes on this sale?
- J.G., Alabama
A: If you haven't closed on the sale, Jeff Soulard, a CPA and certified financial planner in Salem, Mass., says you have two options to defer taxes.
First, you may enter into an installment sale agreement with the other party that would defer some portion of the gain to future tax periods. While this may offer a tax advantage, it exposes you to the risk that some or all of the future payments may not be received.
Your second option is the deferral you mention, Called a "like kind exchange," the IRS allows you to identify similar property (land held for investment) within 45 days of the sale of the acreage. You would have 180 days from the original sale to acquire the replacement property. Keep in mind that the sales money must be held by a third-party trustee, called a qualified intermediary, who will disburse the funds on any replacement property that you buy.
As a result of hurricane Katrina, you may qualify as an "affected taxpayer" eligible for an extension of these time limits. If you qualify, you may receive an extension of up to 120 days to identify and acquire replacement property. This means you could have 165 days to identify replacement property and 300 days to complete the acquisition. This should give you ample time to identify replacement property and determine if you would prefer to recognize the gain on the original sale or use a like kind exchange to defer the tax.
Q: I recently sold a house, which had been my only residence for two of the past five years, and bought a more expensive one. I bought the new house before selling the old house. Does buying four months before selling affect my ability to avoid capital gains taxes?
- M.S., via e-mail
A: The way she understands it, Joan Most, a certified financial planner in Paramus, N.J., says that as long as you resided in the old house for at least two years out of the past five years, the first $250,000 of taxable gain ($500,000 for married couples filing jointly) is exempt from taxes. The fact that your new house is more expensive is no longer part of the tax code, nor does it matter that you bought the replacement home first - you've satisfied tax law requirements.