Condo Owners: To Reduce Tax at Sale Time, Account for Community Improvements

If you live in a condominium, co-operative or other home that's part of a community association, upgrades to the common areas over the years can affect the amount of tax you owe when you sell. It's a tax break that many people overlook.

When you sell your primary residence, assuming that you have lived in and owned it for two of the previous five years, a big chunk of the profit is exempt from federal tax -- $250,000 for a single person or $500,000 for a married couple filing jointly.

But to figure out how much profit you have, you need to determine a few other things, especially your basis, or the amount the home cost you. Let's review some important terms:

· Amount realized. This is the selling price of your old home minus your selling expenses. These expenses include real estate commissions, advertising fees and legal fees incurred exclusively in the selling process.

· Basis. If you bought or built the property, your basis is what it cost you. If it was a gift, your basis is the basis of the person giving you the property. And if you inherited the house, your basis will most likely be the fair-market value as of the date of death. (If you deferred taxes in past sales under old tax laws, that affects your basis -- and is an entire topic by itself.)

· Adjusted basis. This is your basis in the property increased or decreased by such expenses as settlement fees or the costs of additions and improvements that have been made to your property. (IRS Publication 523, "Selling Your Home," includes a worksheet to assist you in determining adjusted basis. That publication provides detailed, helpful explanations of many of the important tax ramifications of a sale.)

· Gain. This is your profit. The gain on the sale of your home is the amount realized minus the adjusted basis of the home you sold.

Thus, to reduce your gain and pay less tax, you want to legitimately increase both your basis and your selling expenses.

Let's look at an example: You bought your condo for $100,000. You sell it for $650,000 and pay a sales commission of $32,500. That means your "amount realized" is $617,500. Of course, that isn't all profit.

You next determine your adjusted basis. If somehow you had no settlement expenses and no costs for improvements over the years, your adjusted basis would be the $100,000 you paid. Subtract that from the amount realized, and your gain would be $517,500. Assuming that you and your spouse are eligible for the full $500,000 profit exclusion, $17,500 of that profit would be taxable as a capital gain.

At the current top long-term capital gain tax rate of 15 percent, you would owe $2,625 in federal tax.

If you make capital improvements to a home over the years -- say, putting on an addition -- you would adjust your basis by what you spent on those improvements. Likely, that would reduce or erase your tax bill.