It’s tax season. If you’d hoped to file right away to get a quick refund, you may be out of luck if you are claiming such things as an energy-efficient-home credit, residential energy credits in general or a mortgage interest credit.
That’s because Congress’s last-minute fiscal cliff agreement in early January forced the IRS to get a late start on modifying the forms associated with those programs to reflect the tax law changes. Those forms are not expected to be available until late February or early March. If you’re in that boat, check www.irs.gov during the next few weeks for an announcement about when they will be ready.
Homeowners, though, will get some breaks. First, for the present at least, Congress did not modify or repeal your right to deduct the mortgage interest you pay. There are, however, some limitations for high-income earners. If you are single and earn more than $400,000 (or more than $450,000 if married), personal exemptions will be phased out and itemized deductions will be limited. If you fall in that category, you must discuss your specific situation with your tax and financial advisers.
Second, despite threats to the contrary, Congress did not increase the capital gains tax rate for people who are not high-income earners. If you are not in the high-income bracket and sell investment property, you will still pay 15 percent federal capital gains tax. Higher-income earners will now be hit with a 20 percent tax.
If you sell your principal house and have lived there for at least two of the five years before it is sold, you can exclude up to $250,000 of your gain if you are single (or up to $500,000 if you are married and file a joint tax return). That can create major financial problems for many people who bought their homes years ago, took advantage of the incredible appreciation during the early part of this century and now will make a profit over the exclusion amount.
Third, the annual gift tax exclusion has been increased to $14,000 per year, from $13,000. That means, for example, that a married couple can give their son and his wife up to $56,000 tax free. (Father and Mother each give $14,000 individually to their son and daughter-in-law.) That additional money will go a long way toward a down payment on a starter home for the young couple.
Fourth, the stepped-up basis has survived. That means the tax basis for a deceased homeowner’s heirs will be the fair market value of the property on the date of death. For example, John bought his house many years ago for $100,000. (For this discussion, we will ignore any improvements that might increase the tax basis.) John just died, and the house is appraised at his death at $800,000. The tax basis for John’s heirs will be $800,000. If they sell the property for that amount, they will not have to pay capital gains tax; they made no profit.
Contrast that with a situation in which John gives the house to his daughter Jenny as a gift. The law is clear: The tax basis of the gift giver (donor) becomes the tax basis of the gift receiver (donee). Thus, unless Jenny can claim the capital gains exclusion mentioned above or can find some other way to legally avoid or defer paying the capital gains tax, she may have to give the IRS a lot of money.
In our example, if Jenny sells the house for $800,000, her gain will be $700,000. Her tax bracket will determine how much capital gains tax she will have to pay. Under the new law, taxpayers who are single and earn more than $400,000 (or married and earn more than $450,000) have to pay 20 percent capital gains tax. For incomes below those threshholds, the 15 percent capital gains tax is still the law. So, for example, if Jenny is in the 25-to-35 percent tax bracket, she will pay 15 percent capital gains tax on the first $400,000 (or $450,000 if married) and 20 percent on the balance.
The moral of that story: In most situations, parents should not give their children the family house but should either sell it to them or let them inherit it on their death.
Congress also preserved a provision helping underwater homeowners, extending the cancellation of qualified mortgage debt through the end of this year. If your home is foreclosed upon or sold in a short sale, your outstanding balance in most cases will be canceled.
To oversimplify: In most situations where a debt is canceled, you will have to pay tax on the amount that was forgiven, even though it’s not money that you actually received.
For years, tax law allowed only a few exclusions, such as on debt canceled in Title 11 bankruptcy or during insolvency. Then in 2007, faced with a growing volume of foreclosures and short sales, Congress passed the Mortgage Debt Relief Act, now known as the Mortgage Forgiveness Debt Relief Act. In general, it allows homeowners to exclude as much as $2 million ($1 million if married and filing separately) of the cancellation or forgiveness of debt on their principal residence. The law had been scheduled to expire at the end of 2012.
How do you know how much of your debt has been canceled or forgiven? If the debt is $600 or more, your lender is required to send you, by Feb. 2 of each year, Form 1099C (Cancellation of Debt), which must state the amount of the debt forgiven as well as the fair market value of any property given up through foreclosure or a short sale.
Homeowners should beware: Some lenders — even if they tell you and the IRS that your debt has been canceled — still try to collect any deficiency, often by turning the matter over to a debt collection company. This has become especially true involving short sales. If you are involved in such a short sale, make sure you know all the terms and conditions before you complete the deal.
For more information, go to www.irs.gov and type “cancellation of debt” in the search field. Also, Publication 4681, titled “Canceled Debts, Foreclosures, Repossessions, and Abandonments,” may be helpful.
Now is the time to start doing your homework, pulling your books and records together and preparing Form 1040. The IRS says that will take taxpayers an average of 22 hours and will cost approximate ly $290. Good luck!
Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. 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.