By Benny L. Kass
Saturday, June 21, 2008

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.

But what if you live in a condo or other home that's part of an association that owns common areas? You could be eligible to adjust your basis to reflect improvements to those common areas.

Say that in the years since you bought, your community association has spent a considerable amount of money improving the property. It has added a new roof and installed a swimming pool.

You own a percentage interest of that association. Generally, your percentage interest will be found at the end of a legal document known as the declaration. The total of everyone's interest in the association should be 100 percent. In a cooperative, your percentage interest should be reflected on your share certificate or proprietary lease.

Let us assume that the association spent $300,000 on that roof and pool and that your interest is 1.5 percent. If you multiply your percentage interest times the total improvements, you get a figure of $4,500. This amount can -- and should -- be added to your basis as "improvements." In our example, by adding $4,500 to basis, the taxpayer is going to be saving $675 in capital gains tax.

It surprises me that many community association owners are not aware of this tax benefit. Particularly for older homeowners who have watched real estate profit build up over many years and now have profit of more than $500,000, every dollar of capital improvements they can document is valuable. In most community associations, records should be available that show total spending for improvements year by year.

Please understand that maintenance and repair items are not added to the basis, but capital improvements -- generally items that have a useful life of one year or more -- are indeed legitimate items to be added to the basis.

Basis is a concept to which most of us pay little attention. However, as we get older and become concerned with conserving the majority of our assets, the concept of adjusted basis becomes critical.

What if you sold your property in the past few years and were not aware of this tax treatment? You may be able to file an amended return, but you must discuss the logistics and the legality of an amended return with your tax advisers.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.