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Columns: Tax Talk
George Saenz, CPA   Expert: George Saenz, CPA
Tax Talk
Time limit on real estate capital gains exclusion
Tax Talk

Avoiding capital gains tax
 

Dear Tax Talk,
My mother is buying a new home using money from an inheritance. She doesn't have to sell her current house, but feels that she needs to in order to take advantage of the $250,000 capital gains tax deduction. She is afraid that she will not be able to claim the deduction after a few years of living in her new home or that the tax laws will change to pre-1997 levels.

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I would like to see her keep the first house and donate the use of it to a charity as a group home. Can she do this without paying capital gains tax in the future? Her first home has increased in value from $100,000 when she bought it in 1982 to $350,000 today.
-- David

Dear David,
Your mom's fears are well-founded. When you convert a former principal residence, you generally only have three years to sell it before it no longer qualifies for the $250,000 gain exclusion.

No one can predict what will happen with the tax laws but it is doubtful the rules will switch back to pre-1997 levels. However, based on current laws, it is clear that your mom will end up paying taxes on the sale of the property if she moves out of it for more than three years. There are no exceptions dealing with property converted to charitable purposes.

If she continued to own the home until she passed away, the property would pass to her heirs with a stepped up basis. That means that the inherent gain would avoid capital gains taxes. Short of holding it to her death, she is better off selling it before the three years pass and using the proceeds to buy another property that she could turn into a group home.

The new home would have a cost basis for determining future gains equal to at least the current market value. If she later needs to sell the home for financial needs, she wouldn't have to worry about paying tax on gains that could have been avoided.

Bankrate.com's corrections policy -- Posted: May 21, 2008
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