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Two homes plus two sales equals capital gains bill

George SaenzDear Tax Talk,
My husband and I were married in October 2004. He purchased a home in January 2004 and sold it in November 2004, owning it for just over 10 months. After adjustments for improvement, commissions, etc., he is still turning a gain of about $20,000. We are trying to find a way to avoid paying capital gains on the profit.

We also now have my home up for sale and I will turn a sizable profit on it. I have owned the house for four years. Will I be OK excluding gains for the 2005 tax year? His home is 60 miles from where I currently work and did work when we met. The distance I would have to drive was the deciding factor on which home to keep and which to sell. Do we qualify for any safe-harbor rule of any sort?

We took the profit from the sale of my husband's home plus additional savings and put down 20 percent on a new home that we are now living in as of this month. Evidently the rules no longer give him any sort of tax break for reinvesting that money into another home, correct? And we can only exclude capital gains on a residence every two years, correct? So if we take advantage of it on his house (if we found a loophole that would allow for that), then we would not be able to take advantage of it on my home?

It seems crazy since the marriage and relocation to be with his new family was the reason he sold the home so soon. It was an unforeseen circumstance, but according to what I read in Publication 523 from the Internal Revenue Service, it does not qualify as a special circumstance. If we end up having to show the gain on our 2004 returns, is there a difference in percentage for him owning it only 11 months vs. over 12 months? Please help. I am working with a CPA that has basically sent me off to do my own research. Thank you.
-- Kelly

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Dear Kelly,
I hope the CPA will understand why you fired him.

Yes, gain on the sale of a property held less than a year, such as your husband's house, is taxed at a higher rate than 15 percent. Basically, it's counted as ordinary income and taxed at your marginal rate. Divorce and separation are unforeseen circumstances, but marriage is not listed as a safe-harbor unforeseen circumstance. Safe harbor is a term the IRS uses to describe certain permitted transactions that if described, will not be challenged by the IRS. Since you do not fall within the safe harbor, you need to look closely at the intent of the law and regulations to see if you can otherwise qualify.

The regulations say a sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer could not reasonably have anticipated before purchasing and occupying the residence. If your husband did not anticipate getting married to you at the time that he bought the house, then it could be said that it was sold for unforeseen circumstances.

The two sales within two years are permitted, but each of you is limited to a $250,000 maximum exclusion. So if you gained $300,000 on your sale and your husband claimed an exclusion on his home, you would include $50,000 in income on your joint return, even though he did not use all his exclusion.

To my readers: I appreciate all the questions you send each week. But because of the volume, you may not have the answer you need with the filing deadline just a day away. If you haven't heard back from me and you really need an answer before you can file, check out the full Bankrate Taxes channel, especially my previous columns and the Tax Tool Box. What you need may be there. If not, consider seeking an extension of time to file your federal and state returns so you'll have time to get the tax answer you need. But remember: If you do get an extension, be sure to pay what you might owe to avoid interest and penalties.

-- Posted: April 14, 2005




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