This week we're tackling taxes. I know, I know: April seems a long way off. But what you pay next April 15 has everything to do with what happens this year. And in light of the fact that this is an election year, our representatives in Washington have delivered a dose of tax relief that I'm sure they hope will seal their respective re-election bids.
Essentially, the legislation passed by Congress on Sept. 23 extends a number of tax breaks that were introduced as part of the Economic Growth and Tax Relief Reconcilation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). One of these tax breaks had already expired at the end of 2003 (and therefore would have affected your taxes for 2004); others were set to expire at the end of this year.
Parents will be happy to learn that the $1,000 child tax credit will now apply through 2009. The amount was slated to drop to $700 in 2005.
The measure also extends "married penalty" relief: the 15-percent income tax bracket for married couples will remain twice the amount that it is for single taxpayers. If this had not passed, we'd go back to the old situation in which working couples would end up paying more taxes than if they'd been single.
The 10-percent income tax bracket introduced by JGTRRA had its phaseout extended as well. (Well, at least until another Congress decides to taketh away. You just can't use the word "permanent" when discussing the tax code.)
Last but not least, this legislation also slaps another Band-Aid on the Alternative Minimum Tax. As I've written before, when enacted in 1969, the AMT was supposed to prevent "the rich" from avoiding taxes by using tax avoidance schemes such as shelters and write-offs. It essentially does this by elminating many of the deductions (such as for state taxes paid, and for dependents) you normally get. This essentially means you have a higher amount of income subject to tax under the AMT than under the regular ssytem.
Trouble is, the AMT now snags millions of middle-class taxpayers-especially those who live in states with high income and/or property taxes. In fact, the Tax Policy Center projects that "97 percent of married taxpayers with two or more childrend and incomes of $75,000 to $100,000 wil be affected by the AMT by 2010" unless significant changes are made.
Unfortunately, all this measure does is buy Congress more time to think about what to do. But, hey, it's better than nothing. It extends for one more year — through 2005 — the higher exemption amount instead of having this drop to where it was prior to 2001. Hmmm, do you think that might have gotten some taxpayers/voters upset?
In fact, this provision alone will save taxpayers an estimated $22 billion in AMT according to the Joint Committee on Taxation. In addition, Greg Jenner, Acting Assistant Secretary for Tax Policy at the Treasury Department, points out that taxpayers subject to the AMT tax rates of 26 percent and 28 percent will again be able to use their personal credits to reduce their AMT taxable income. If this bill hadn't passed, taxpayers subject to the AMT would not be able to use their child tax credits or, for parents with college students, the Hope or Lifetime Learning credits.
Mark Luscombe, principal analyst at CCH, a major provider of tax information, says it's estimated that in another 5 years the AMT will be generating more tax revenue than the regular income tax system. Which has got some folks wondering whether at the point Congress might simply repeal the old tax code and switch everyone over to the AMT.
In the meantime, keep up the pressure on your Congressional representatives to resolve this issue one way or another. At this point, millions of Americans are having to spend time and money to calculate their taxes twice- the regular way and the AMT way — to see which one produces the highest tax bill. (Naturally, that's the one you have to pay.)
Although it didn't get a lot of splashy headlines, both houses of Congress overwhelmingly approved the measure. Democratic presidential candidate Senator John Kerry and vice presidential candidate Senator John Edwards did not vote on the measure.
This legislation now heads to the White House. In light of the fact that President Bush pushed for the original versions of these tax breaks in JGTRRA, Jenner says "there's no reason" why he wouldn't sign it. Of course, none of these provisions will take effect unless and until he does this.
We sold at a substantial profit (for us at least) a piece of property that was not a residence, and purchased another, more expensive property. The new property does have a residence on it. I have been told several different things concerning our tax liability:
1. I don't have to pay any taxes as this was profit made on real property that we held more than five years. (It was not our residence and I find this hard to believe.
2. We must pay capital gains in the amount of 15 percent.
3. That because we invested in a more expensive property, we owe no taxes as long as we don't use it as our residence for at least two years.
No. 1 came from a tax accountant and No. 2 and No. 3 from different people I reached on the phone at the IRS.
Your skepticism is well-founded. The correct answer is #2, assuming you're not in the 10-percent or 15-percent income tax bracket (in which case your capital gains tax would be 5 percent this year).
The tax code makes a distinction between a profit you make on the sale of your home and real estate that you purchased as an investment.
A homeowner who sells his/her residence can exclude to $250,000 in profits if the owner files as a "single" taxpayer; a married couple can exclude up to twice that amount — $500,000. Any gain in excess of these amounts is taxed at capital gains rates.
For example, say you're single and have lived in your condo for the past three years. Real estate prices in your neighborhood have soared and you decide to cash in. You walk away with $175,000, tax-free. Period. There are no restrictions on what you must do with that money.
To qualify for this tax break, the home must have been used as your "principal" residence for at least two of the past five years. If you were to be audited, the IRS would look at such things as how much time you spent at that address each year? Is it near where you work? Is it the address you used when you registered to vote? Is it where your bills are sent? Is it the address on your driver's license?
If you don't meet the "2-out-of-5-years" rule, there is a provision for a partial exclusion on the gain under certain circumstances such as when the reason for the sale is due to a change in your place of work, or health reasons.
Finally, you have to wait two years before you can use this tax break again.
However, in your case, Douglas, you admit that the property you sold was not your residence, so it clearly does not qualify for this tax break.
Instead, assuming you owned the property for at least a year, you will owe long-term capital gains tax on the profit. The good news is these rates are substantially lower thanks to tax legislation passed last year. Instead of 20%, the top capital gains rate is now 15 percent (a 25-percent reduction) through 2008.
One note of caution comes from CCH's Luscombe who says "if you've depreciated the property over the past 8 years, a portion of the gain might be subject to a 25 percent tax rate." It falls under the heading of "depreciation recapture." (Internal Revenue Code Section 1250, in case anyone asks.)
My advice is that you find a competent tax advisor who can make sure you figure this corectly.
P.S. The reference to rolling over the proceeds of this sale into a more expensive piece of property is totally outdated. That rule — which only covered your residence — was replaced in 1997(!) by the current one allowing you to exclude part of the gain.
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