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.
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.
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.