Home Sale as Capital Gain

The gain on the sale of a home is considered a gain on the sale of a capital asset. Any taxable profit you make is subject to a maximum long-term capital gain rate of 15% (5% for gains in the 10% to 15% federal income tax brackets) if you owned the house for more than 12 months. Gain on the sale of a home may only be taxable to the extent it exceeds $250,000 ($500,000 for joint filers) if certain conditions discussed below are met.

To determine your profit (gain), you subtract your basis from the sale price minus all costs and commissions. For instance, if you sell a house for $250,000, and must pay your broker 6% of the sale price — or $15,000 — your sale price for determining capital gain tax is $235,000 ($250,000 minus $15,000).

Say you bought that house 20 years ago, for $35,000. You have since redone the kitchen and bathrooms, put in new windows, added a bedroom, and a new roof. Your basis in the house is $35,000 plus the cost of all of the capital improvements you have made, providing you have paperwork to verify the costs. Let’s assume the total cost of those improvements over the 20 years you owned the home is $40,000. In such a case, your basis would be $75,000. Your capital gain would be $235,000 minus $75,000, or $160,000. If you are in the 28% federal tax bracket or higher, your capital gain tax on your home sale would be $32,000 unless you use the principal residence exclusion.

The Primary Residence Exclusion

A $250,000 exclusion for single filers ($500,000 for joint filers) is now available to all taxpayers. You can claim the exclusion once every 2 years. To be eligible, you must have owned the residence and occupied it as a principal residence for at least 2 of the 5 years before the sale or exchange. If you fail to meet these requirements by reason of a change in place of employment, health, or other unforeseen circumstances you can exclude the fraction of the $250,000 ($500,000 if married filing a joint return) equal to the fraction of 2 years that these requirements are met.

When Can Home Office Expenses Be Deducted?

The costs associated with maintaining a home office can be deducted only if strict IRS guidelines are met — generally that the office is used exclusively for business purposes.

The Taxpayer Relief Act of 1997 has eased the requirements for determining if the costs associated with a home office can be deducted. The new law states that a home office qualifies as a “principal place of business” if (1) the taxpayer uses the office to conduct administrative or management activities of a trade or business and (2) there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business.

Deductions will continue to be allowed for a home office meeting the above two-part test only if the taxpayer uses the office exclusively on a regular basis as a place of business and, in the case of an employee, only if such exclusive use is for the employer’s convenience.

Home Office Deduction Limits

The home office deduction is limited to the gross income from the activity, reduced by expenses that would otherwise be deductible (such as mortgage interest and taxes) and all other expenses related to the activities that are not house-related. A deduction isn’t allowed to the extent that it creates or increases a net loss from the activity. Any disallowed deduction may be carried over to future years.

Taxation of Long-Term Capital Gains

The maximum tax rate on net capital gain is 15% for most taxpayers, and 5% for taxpayers in the 10% and 15% tax rate brackets for property sold or otherwise disposed of after May 5, 2003 (and installment sale payments received after that date). The reduced rate applies for both the regular tax and the alternative minimum tax.

(Note: The higher rates that apply to unrecaptured section 1250 gain, collectibles gain, and section 1202 gain have not changed.)

Tax Treatment of Capital Losses

If you incur losses from the sale of a capital asset, you can deduct those losses to the extent they equal capital gains from the sale of other assets. If your losses exceed your gains, you can only deduct up to $3,000 ($1,500 if you are married and filing separately) of capital losses in a tax year against other income on Form 1040. You can carry losses forward and continue to deduct $3,000 ($1,500 if filing separately) annually against other income until your losses are used up.

Advantages of Gift Giving

You may have many reasons for making gifts — for some gift giving has personal motives, or others, tax planning motives. Most often you will want your gift giving program to accomplish both personal and tax motives. A few reasons for considering a gift giving plan include:

• Assist someone in immediate financial need
• Provide financial security for the recipient
• Give the recipient experience in handling money
• See the recipient enjoy the property
• Take advantage of annual exclusion
• Paying gift tax to reduce overall taxes
• Giving tax advantages gifts to minors

Gift Tax Annual Exclusion

Probably the easiest way to reduce the size of your taxable estate is to make regular use of the gift tax annual exclusion. You may give up to $13,000 each year to as many persons as you want without incurring any gift tax. If your spouse joins in making the gift (by consenting on a gift tax return), you may (as a couple) give $26,000 to each person annually without any gift tax liability.

Unlimited Gift Tax Exclusion

In addition to the $13,000 exclusion, there is an unlimited gift tax exclusion available to pay someone’s medical or educational expenses. The beneficiary does not have to be your dependent or even related to you, although payment of a grandchild’s expenses is perhaps the most common use of the exclusion. You must make the payment directly to the institution providing the service — the beneficiary himself or herself must not receive the payment.

Gift Programs and Your Estate

Use of the gift tax exclusion in a single year may not affect your estate tax situation significantly, but you can reduce your taxable estate substantially through a planned annual program of $13,000 (or $26,000 if you are married) gifts. All gifts within the exclusion limits are protected from federal estate taxes.

In addition to reducing the size of your estate, another major tax advantage of making a gift is the removal of future appreciation in the property’s value from your estate. Suppose that you give stocks worth $50,000 to your children now. If you die in 10 years and the stock is worth $130,000, your estate will escape tax on the $80,000 appreciation.

He Who Fails to Plan, Plans to Fail

It has been said that no one plans to fail, they simply fail to plan. Nowhere is this idea more applicable than when it comes to meeting our retirement objectives. A sound financial plan can be the difference between meeting one’s retirement objectives and facing the discouraging surprise of one caught unprepared and with too little time remaining to change their financial course.

At the very least, ongoing retirement planning will help you understand the financial demands of retirement, and make those decisions that are best suited to applying limited resources to potentially unlimited demands.

Retirement Income Needs

Recent studies have found that during retirement the average American needs between 60 and 80 percent of their pre-retirement income in order to maintain their pre-retirement standard of living. Almost everyone needs less money during retirement than before. How much you need during retirement will be a function of your personal spending habits. Consider the following factors in estimating your retirement income needs:

• You may be supporting children now who will be self-sufficient by the time you retire.
• Your work related expenses would be dramatically reduced, if not eliminated, once you retire (commuting costs, daily meal expenses, licensing fees, etc.).
• For many, their mortgage will be paid off either by the time they retire, or within a matter of a few years after retirement, reducing housing expenses.
• Hopefully you are saving money on a monthly basis for retirement. During retirement you can plan your needed monthly income without factoring in a “retirement saving” amount.
• Many retirees find themselves in a lower income tax bracket. This is due, in part, to having their main sources of income change from fully taxable earned income to tax advantaged income sources.

Sources of Retirement Income

Once you have estimated your target retirement income, you are ready to begin to evaluate what sources of income will be available to you to meet your monthly needs. Generally speaking, your sources of retirement income fall into three categories, which we will discuss below.

Government Sources. The federal government has created something of a “safety net” for retirees called Social Security. Social Security is available to everyone, but the amount you receive will be based on how much you earned during your working years.

Company Sponsored Plans. Many employers offer company sponsored retirement plans. These plans come in many forms but generally can be broken into two categories. Defined Benefit Plans are normally funded entirely by the employer and guarantee a retirement benefit based on a combination of years of employment and employment earnings. A Defined Contribution Plan may be funded by the employer, employee or a combination of the two. The employee owns an account balance (subject to vesting) made up of contributions and earnings. At retirement, the employee decides how they will withdraw the balance they have accumulated.

Personal Savings. The most important, and often most overlooked, source of retirement income is one’s own personal savings. Savings directed to IRA accounts, directly held assets, home equity, etc. will largely determine how financially secure your retirement years will be.

Changing Your Current Course

There are many ways that proper planning can improve your current retirement outlook. The more time you have to prepare, the more change you can effect in your retirement income. A sound financial plan and ongoing professional advice can help you obtain your retirement objectives

Unfortunately, Social Security retirement benefits have gradually been reduced in real terms, and the age one needs to attain in order to qualify for retirement benefits has been increasing steadily. iven current retirement trends, these retirement benefits will continue to be more and more difficult for the government to fund.

In addition, most employers have moved away from traditional defined benefit plans in favor of “defined contribution plans” where the employee is often responsible for funding, investing, and distributing plan funds.

These and other recent trends have dramatically increased the need for every individual to have a sound, long-term investment plan. Your personal investments may be what makes the difference between relying on a fixed income provided by others, and a financial independent retirement.

It is never too early, or too late to begin saving for retirement.

Today, over 95% of the people over 65 receive a Social Security benefit check. For many this monthly benefit represents their main source of retirement income.

Contributing to the Social Security Program

Every year you work, you and your employer contribute equal amounts to Social Security, as required by the Federal Insurance Contribution Act (FICA). 6.2% of your earned income is withheld from your paycheck to fund Social Security. Another 1.45% went to Medicare for a total deduction of 7.65%. Your employer matched your contributions with an additional 7.65% of your earnings going into the programs mentioned.

You may be pleased to know that there is an earnings level at which Social Security payments are no longer required. No Social Security withholdings are required on any earned income over $102,000 (in 2008); the amount contributed to Medicare has no earnings cap, however.

Your Social Security Benefits

If you were born before 1938 you may collect full Social Security benefits when you turn 65, or you may collect 80% of your benefit if you retire at 62. For people born after 1938, Normal Retirement Age (NRA), or the age at which you can receive full social security benefits, gradually increases upward from age 65 to age 67. Visit http://www.ssa.gov to determine your NRA. When you die, your surviving spouse is entitled to your benefits, unless he or she would collect more based on their own earnings history.

Taxes on Social Security Benefits

Once you begin receiving retirement benefits, you may have to include them in your taxable income reported to the IRS each year.

If your total income for the year, including half of your Social Security and your tax-exempt earnings, is greater than $32,000 ($25,000 for single taxpayers) you will owe federal income tax on part of your Social Security benefits. The IRS provides you with a worksheet to figure out how much you must include in your taxable income each year.

Record of Social Security Earnings

When you get a Social Security card, your Social Security benefit account is open. It is not activated until you begin earning income. Once your earnings begin, the amount you contribute each year is recorded.

The accuracy of this record is important. You can get a copy of your earnings record from the Social Security Administration (SSA). Fill out Form 7004 and mail it to SSA. The forms are available at your local Social Security office or by calling 800-772-1213. If you discover your record is wrong, you can ask that it be corrected, though you must supply evidence of errors. The SSA encourages people to check their earnings records every three years or so, since the earlier a problem is found, the easier it is to prove and correct.

Traditional IRA

Traditional IRA – Individual Retirement Account, is a tax-deferred investment and savings account that acts as a personal retirement fund for people with employment income. The maximum contribution is $5000 annually in 2010 and 2011 with an additional $1000 if over 50 years old. There are two primary types of IRAs: Regular and Spousal. Regular IRAs are designed for individuals with earned income, while Spousal IRAs are designed for married couples in which only one of the spouses has earned income. You have the option of investing in a wide variety of investments. (See IRS Publication 590).

For Regular and Spousal IRAs:

Your contribution is fully tax-deductible if:

• Neither you nor your spouse participated in a company-sponsored retirement plan.
• You contributed to a company-sponsored retirement plan: are single and earned less than $56,000 in 2010 and 2011 or married and filing jointly and had a joint income of less than $89,000 in 2010 and 2011.

Your contribution is partially tax-deductible if:

• You contributed to a company-sponsored retirement plan: are single and earned $56,000 but less than $66,000 in 2010 and 2011 or married and filing jointly and had a joint income of $89,000-$109,000 in 2010 and 2011.

Your contribution is not tax-deductible if:

• You contributed to a company-sponsored retirement plan: either single and earned more than $66,000 in 2010 and 2011 or married and filing jointly and had a joint income of more than $109,000 in 2010 and 2011.

Non-Deductible IRA

Similar to the Traditional IRA, the Non-Deductible IRA allows a working individual under the age of 70 ½ to contribute up to $5,000 of compensation each year. Unlike the Traditional IRA, the Non-Deductible IRA contribution is made with ìafter-taxî dollars ñ the income tax deduction allowed the Traditional IRA is not available to the Non-Deductible IRA. For the most part, the Non-Deductible IRA is utilized by those who do not qualify for the Traditional IRA, but can benefit from the “tax deferral” of earnings allowed with the Non-Deductible IRA.

Roth IRA

Roth IRA – is an individual retirement account with a maximum contribution of:

• For 2009 and beyond the maximum contribution is $5,000 with additional $1,000 contribution.
• Contributions to a Roth IRA are not tax-deductible. However, the investments grow tax free and earnings may be withdrawn tax free after 59 ½ as long as the account has been open 5 years.
• Eligibility for contributions to a Roth IRA is phased out for married couples filing jointly with an AGI between $167,000 and $177,000 for 2010 and 2011 and single individuals with an AGI between $105,000 and 120,000 for 2010 and 2011.
• See IRS Publication 590

To Help Decide Which IRA Is Best For You…

Many factors must be considered, such as current and future income tax rates, investment returns, what the money will be used for and when, income, marital status, and the availability of a retirement plan at work. We can assist you in examining your personal situation to help you tailor your retirement plan to your individual needs.

While Roth conversions are not subject to early distribution penalties, they are subject to income tax.

Any earnings distributed prior to age 59 1/2 would be subject to penalty and tax.

Your tax-free potential is maximized if you pay the taxes from your current income or personal savings, not your IRA. Make sure you have the cash to pay the taxes required to convert to a Roth IRA.

Assets converted to a Roth IRA must be invested for at least five years before taking distributions or a significant income tax penalty may apply.

For tax years starting in 2010, the $100,000 modified AGI limit for conversions to Roth IRAs is eliminated and married tax payers filing a seperate return can now convert amounts to a Roth IRA

Workers today, however, are retiring at earlier ages than in years past. In just the last few years, for example, the average age for retiring has dropped to age 63. And many younger workers are planning on retiring even earlier.

What You Give Up

This trend towards retiring earlier is not without its costs. Here are a few of the financial results of early retirement which must be considered carefully:

• Not only are Social Security benefits reduced for early retirement, but the “full benefit” age is being gradually increased to age 67.
• Retiring early often eliminates ones greatest earning years and the resulting savings that would have taken place in these years.
• The annual benefit provided by employer sponsored defined benefit pension plans is usually based on a combination of years of service and your ending salary. Both are reduced by early retirement.
• Health care costs tend to increase for retired individuals. Benefits that were once paid for by employer sponsored coverage often become the responsibility of the retiree.

Consider Your Options Carefully

Choosing when to retire is one of the most important financial decisions you will make. Consider your options carefully. Careful planning can help ensure you a happy and financially independent retirement.