Reminder on Capital Gain Tax Law Change for Primary Residence

A change in the Housing Assistance Tax Act of 2008 changed the rules regarding capital gains on the sale of a primary residence.  Under the prior system, homeowners were able to exclude up to $250,000 ($500,000 for married couples) worth of capital gains on the sale of a primary residence.  One of the rules in order to qualify for the capital gain exclusion was that a property owner had to use the real estate as a principal residence for at least two of the previous five years.  As such, homeowners with rental and vacation property began to sell their primary residence without capital gain and then moved into their second home or rental property so that they could avoid capital gain upon sale of that property also. 

 

The Housing Assistance Act of 2008 sought to close that loophole.  The new law will allow the exclusion of a portion of the capital gain based upon a new formula that seeks to take into account years that the real estate was not used as a primary residence.  Use of the real estate as a primary residence has been termed "qualifying use" and use of the real estate for other purposes is called a "non-qualifying use".

 

Beginning on January 1, 2009,  capital gains are determined based upon the following formula:

(Time of non-qualifying use after 1-1-09) divided by (time of total ownership) = % of exclusion

One benefit here is that non-qualifying use for periods before January 1, 2009 do not count for purposes of making the calculation.  Obviously, properties that have been used exclusively as a primary residence will be eligible to exclude the entire gain up to $250,000 ($500,000 for married couples).

As a result, property owners who have held non-primary residence real estate for long periods of time can still take advantage of major tax savings by converting non-qualified property into qualified property (because all non-qualifying time prior to 1-1-09 is not included).  It makes sense to evaluate capital gains strategy based on this law.

Landlords Subject to New Tax Requirements for 2011

The brand new Small Business Jobs Act of 2010 enacted by President Obama in September, 2010 includes a new provision that affects landlords.

Beginning in 2011, all landlords must provide 1099-MISC forms to all service providers for payments in excess of $600 during the year. Previously, only landlords who rented property as a "trade or business" were required to make a filing. Now, the law extends to any and all landlords, even those who rent out a bedroom or make a short term rental. The law amends the definition of being engaged in the "trade or business" of renting property to include "a person receiving rental income from real estate".

As such, all landlords must issue a 1099-MISC to any service provider who the landlord pays more than $600 in any given year. This means that if you rent your property and pay an attorney to help with an eviction and pay an invoice for $1400, you must issue the attorney a 1099-MISC. Same goes for landlords who, say, pay a cleaning service $75 per month ($900) to clean their rental property.

The law does provide three exceptions. First, it excludes active members of uniformed services or intelligence employees who are renting their primary residence while on assignment. Next, the law excludes any individual who receives rental income of not more than the minimal amount as determined by the IRS regulations. No such regulations yet exist. Finally, it provides a hardship exception for landlords, as determined by the IRS regulations. Again, the IRS has not issued any regulations as to what sort of hardship might be sufficient to excuse performance.

Interestingly, the law also provides for increased penalties for failure to file informational returns.

The 1099-MISC forms must be filed in early 2012, however, landlords must begin the process of maintaining their records beginning as of January 1, 2010. The prudent landlord will collect the name, address, and federal employer identification number (FEIN) from people they pay for goods and services. This means landlords must also become facile with IRS form W-9.

Prudent landlords will be keeping their books current beginning with the new year. Better yet, prudent landlords will want to get a "landlord tune-up" for 2011 from the attorneys at Reda | Ciprian | Magnone, LLC.