What Will my Taxes Look Like upon Sale?

Racing the clock so you get to the plant sales......  

Clients have been asking me questions about the details of selling their long-held home--as they should!  It's an important transaction involving what's likely to be your largest asset.

 I always say, "I'm not your attorney nor your tax advisor, so check with them, but in the main, ....."  Issues range from how much taxes will be due/how much they will net for the future, to how to coordinate selling and buying in a convenient time frame, to whether it's risky--or possible!--to buy a new home before circling back to sell the old, to are there ways to avoid taxes or property tax increases (given that Prop 13 suppresses your property tax bill in your current home).  I've covered many of these issues before, but will reiterate in the next couple of months.

I've asked Piedmont tax advisor, Dean Emerita and current professor of the Golden Gate University Braden School of Taxation, Mary Canning to answer the most common questions I get.

1.  In the main, what kinds of taxes are due to the US and California when you sell your home?  Can you assume a $1 million purchase price, $2 million sale price and $200,000 of transaction costs (escrow fees and brokerage costs when I bought and sold, and paint and new carpet when I go to sell)?

Assuming taxpayers are married filing jointly, and they have lived in their home as a principal residence for 2 of the previous 5 years before the sale, the taxes would be calculated as follows:

 $2,000,000 sales proceeds

-$140,000 (combination of commissions paid, selling costs, escrow fees, staging and other fix-up costs)

-$1,060,000 cost basis (purchase price plus closing costs paid on purchase)

$800,000  capital gain

-$500,000  Section 121 capital gain exclusion ($250,000 if single)

$300,000 Long term taxable gain

Federal tax liability at 20% preferential long term capital gain rate: $60,000

California tax liability at 10.3%*   $30,900  

So after the sale and payment of taxes and expenses, you would have $1,769,100 in hand.

* Note CA does not have a fixed preferential long term capital gain rate as Federal has.  California's tax rate can range upwards from 10.3% on $300,000 of gain to a top rate of 13.3% (with mental health tax on $1,000,000 of taxable income) depending on the taxpayer's other taxable income in the year of sale.  

2.  What if I added a master suite?  Replaced the roof?

These expenses would increase the cost basis in the above example, thereby reducing the net taxable gain and taxes due.

3.  What if I still have a $1 million loan on the property?

This affects after tax "cash-in-hand," but not the amount of tax due: 

$2,000,000 sales proceeds

-$140,000 commissions, staging and fix up costs, other escrow and sales costs

-$90,900 (combination of Federal tax liability $60,000 and State tax liability $30,900)

-$1,000,000 payment of debt

Or $769,100 net spendable cash 

4.  Isn't that a lot of tax, compared to investing $1 million in stocks?

The tax liability (rates) would be the same, assuming that the stock was held for more than one year.  There are fewer costs associated with the purchase and sale of stock, but generally the dollars invested in the purchase of a home are initially only the downpayment.  Mortgage interest is fully deductible on up to $1,100,000 of debt used to purchase and improve the home so long as the debt is secured by a mortgage against the home.  Any debt used to purchase stock is investment interest and is subject to limitations on deductibility. 

5.  Is there a way to avoid paying taxes?  I thought a home sale was tax-free as long as I bought something more expensive?

It was never tax free.  Prior to a tax law enacted in 1997, you could defer (but not escape) the gain on the sale of a residence so long as the purchase price of the new home equaled or exceeded the sales price of the old home.  This law was repealed for sales after May 6, 1997 and the current law taxes the sale of a residence in the year of sale, but added either a $500,000 (if filing jointly) or $250,000 (if single) exclusion to reduce the gain on sale, and thereby reducing the tax. This exclusion, often referred to by the governing Internal Revenue Code section 121, is available for sales of homes that were the taxpayer's principal residence for 2 of the 5 years preceding the sale. See application of this exclusion in computation above at Q&A 1.

Although generally not applicable to the sale of a principal residence, a tax-deferred exchange under Internal Revenue Code Section 1031 provides a way to avoid paying taxes on the sale of property used in a trade or business or held for investment (for instance, rented out), if the proceeds are invested in a replacement property (and other requirements are met).  Although the tax liability on the sale is deferred, the basis of the new property is reduced by the amount of taxable gain on the sale of the old property (which will, among other things, affect the amount of depreciation available on the new property).   

If the new or replacement property is later sold and the taxpayer wishes to "cash out," rather than reinvest in yet another property, the deferred tax will be due, together with the tax on the gain of the new property.

Sometimes, it is possible to combine the 121 exclusion and the 1031 deferral - a personal residence is converted to rental property and then exchanged into other rental property, providing income into the future.  

If that same taxpayer rents out the new property for some period of time (a rule of thumb is 1 year), the taxpayer may then convert the new property back to a principal residence.  The tax advantages of the Section 121 exclusion and the 1031 deferral are preserved so long as the new property met the requirements of investment property.    

7.  What about Proposition 13 Transfers?

Before Proposition 13 passed in 1978, the average property tax rate in California was 3% of assessed value and there was no limit on annual increases. Under Proposition 13, the assessment rate is now only 1% for all California property (although counties are allowed to include additional assessments), and annual tax increases are limited to no more than 2%. 

 

Proposition 60 was passed to allow taxpayers age 55 or older to buy a new home but keep their same property taxes so long as the new home is of equal or lesser value and is located in the same county.  This is a once-in-a-lifetime election.  Proposition 90 was passed to allow for transfers from one county to another (so called "inter-county transfers") if the new county has adopted an ordinance allowing such transfers.   Under certain circumstances this can be a very beneficial tax savings.  However, the counties accepting transfers are limited with currently only 11 out of a total of 58 California counties participating [see this list and info sheet from the state for more info-MK].  

Further, one should carefully consider the value of this step as the savings may not be as significant as they might initially seem, especially where the taxpayer is buying a much less expensive home.  

Thanks Mary!  She can be reached at canning.mary@gmail.com.  

Mary, together with exchange specialist James Callejas of IPX 1031 helped us arrange a 1031-121 exchange when we bought our home on Pacific and 15 months later, after renting it out, sold our home on Pala.  We were able to pull out $500,000 in cash (the Section 121 part), and invest the balance of our sale proceeds in rentals in the area and in Portland.  (We now have two sons in Portland, and could potentially convert one of the rentals there into a pied a terre at some point in the future, converting the condo back into a personal residence.  If we did that and later sold it prior to our deaths (when the estate tax rubric would kick in), there's some complicated tax calculations to be done).

We deferred tax, and could have used the $500,000 as a downpayment on a new home, securing a mortgage for the balance.  Or you could set your sights on Ashland, OR, for instance, buy your retirement home for $500,000 cash, and live mortgage free.

The older of us (that would be me....) wasn't 55 yet, but if I had been, we would be saving about $10,000 a year in property taxes by taking advantage of Prop 60.  Bummer.  But a number of my clients want to sell their $2 million home and buy a $1 million home elsewhere.  In Mary's scenario above, the future tax bill would be about the same either way, so no need to feel limited to 11 California counties if you really want to be in Marin (which is not on the Prop 90 list of cooperating counties).

If you're trying to think creatively about getting from here to there, be sure to work with an agent who knows the process and has a stable of tax, exchange, and property management professionals ready to make it happen for you.  

So go to the plant sale and then take a hike in that great East Bay asset that is Tilden Park!

Out of Order!--3Q16 Piedmont Update--

Last newsletter we talked about softening markets in San Francisco and the South Bay (but not here).  This quarter we see just a few signs of potential slowing.  From July to yesterday, 30 homes sold in Piedmont (on the MLS) at an average price of $2.328 million ($789/sf) and median of $2.134 million ($805/sf).  This compares with 26 homes selling for almost exactly $2.1 million median and mean in 3Q15 (and 44 in 2005).  The median home sold in 13 days (two weekends of open houses) though one home sold after nearly four months, dragging down the average.  The typical sale price was about 5% over asking, compared to something closer to 10% over asking a year ago.

Eight of the 30 homes sold for under the asking price--a new thing--though interestingly we also saw homes with only one offer selling for over the asking price.  Presumably the agent didn't realize that there was no competition--always important to do your due diligence!--or the sellers convinced the buyers through negotiation to up their number.  

Across the East Bay, we are certainly seeing sellers put their home on the market at an attractive, below-market number, hoping for multiple offers, but then get one or a couple offers below a number they think is fair.  Sometimes the house comes off the market, sometimes the price goes up to that magic number on the MLS, but generally, sellers have still been getting roughly what they want, perhaps after another couple of weeks, together with relate anxiety. But as we head into the more quiet 4th quarter of the year, things seem to be cooling at tad.

In our nearby Oakland neighborhoods (94610,11, 18), the average home price was $1.043 million, and $961,000 through 3Q15, an 8.5% bump. Coinci-dentally, 241 homes sold in both windows, about 20% fewer than in top-of-the-market 2005. 

My CSL Kitchen Tour Weekend for a Home Sale is Still Open!

As many of you know, I've gotten into the habit of putting a centrally located home on the market over the weekend of the Children Support League Heart of the Home tour (this year scheduled for April 28-29th; see http://wehelpkids.org).  We annually have 2,000 well-networked folks driving through central Piedmont, and they are all going to chat with friends afterwards.  Wouldn't you like one to stop into the all-day open houses and then later call a friend and say "you need to get young John over here to look at this Piedmont house I saw on the market this morning--it's got X, and Y, and Z, just as he wants!"  That self-selected but carefully targeted word-of-mouth marketing, backed up by thoughtful advertising (including in the tour booklet itself) is priceless.   

And the payoff has been dramatic.  Last year's offering garnered 11 offers and went 48% over the asking price, and previous years' outcomes have been similarly impressive.  When a fixer, or a cosmetic fixer is the subject of all-day Friday and Saturday open houses, plus the usual Sunday afternoon open, as was the case last year, I throw in my other specialty--the Renovator's Open House which earned front page coverage ten years ago by the 

San Francisco Chronicle.

So if you're anticipating a spring sale, get in touch and reserve my time!

Say Goodbye to 2016

With taxes kept low by Prop 13, mortgage rates locked-in at historic lows, and the prospect of capital gains taxes dropping in the next tax reform package, we potential sellers are experiencing what economists call "stickiness."  We're not overcoming inertia and moving when our circumstances change, but rather we're responding to incentives and staying put.  

As a result, a large proportion of my work is educating my clients so they are comfortable and confident whenever they decide to make their next move.  What's an electronic signature program?  Why should you care about the financial strength of a new co-housing development? What options are out there to defer or avoid capital gains taxes on the sale of a long-held home, and make a planned charitable donation or get some nice monthly income in the bargain?  I help people make great real estate decisions, and I get paid when they or their friends and colleagues rely on my advice when they buy or sell a home.

As I've said here before, the center of the Bay Area economic engine has been shifting gradually from Silicon Valley to San Francisco and Oakland.  Based on Pacific Union's transaction data, we're increasingly seeing tech households purchasing in the East Bay rather than households from the legal, management and finance/insurance/real estate (FIRE) fields.  And that means a number of tech households, looking for great schools and good housing stock, are focusing on Piedmont for the first time. 

The median home price in Piedmont increased 5% this year (based on MLS data, through 12/29).  Since 2014, prices jumped from a median $1.75 million ($652/sf) to $2.1 million ($791/sf), with a 15% increase in 2015.  Not only did the rate of price increases slow down in 2016, so did the volume--only 95 homes traded in 2016 in contrast to 147 in 2014, and 116 in 2015.  In fact the total volume of real estate sold in town declined by nearly $50 million/25% between 2014 and 2016, meaning transfer tax revenue is down rather dramatically.  

We saw this decline in the number of homes sold across all markets and submarkets in the East Bay, even though underwriting criteria have eased.  Downpayment requirements are the likely culprit--20% of a big(ger) number is a big(ger) number, and area incomes have not kept pace.  With interest rates increasing since early November, we're likely to see more Bay Area first-time buyers falling away as their window for homeownership closes.

Prices in Berkeley shot up even further, particularly for the sweet spot of $1 million-$1.5 million homes.  There, prices went up 16% in 2015, and then 8.6% over the course of this year.  At this point, buyers will pay roughly the same for a 3 BR/1 BA home in 1600 sf in Berkeley as in Piedmont!  

Prices in Oakland 94610 (Crocker), 94611 (Montclair/Piedmont Ave.) and 94618 (Rockridge/Upper Rockridge) also increased about 25% over the two-year window, but in a reverse of the trend in Piedmont and Berkeley, prices rose nearly 15% in 2016, but only 9% the previous year. Perhaps regional buyers have come to appreciate the great commutes, restaurants, movie houses, shopping districts and those fabulous La Farine savory morning buns only more recently. The entire Oakland market is up 31% over the two-year window, as neighborhoods recover from those deep dives of the housing crisis, and first-time homebuyers again find that Oakland neighborhoods offer affordability.

As always, I'm happy to help you think through your real estate options, whether buying, selling, renting or renovating.  If you have colleagues, clients, friends or family who plan to buy or sell in the East Bay Hills, I promise to work hard to earn their trust, protect their privacy, and exceed their expectations.

Happy New Year!

Personally, I'm anxious to move on from last fall.  So let's all recommit to act local again!  Well, at least after vacations--

We've continued our commitment to take long hiking vacations; this past year to the Inner Hebrides and to the High Sierra.  Those long hikes, interrupted only by a lovely shooting star or a tasty mushroom, provide time to think and plan, and sharpen my commitment to service, both professionally and personally.  Even during the workyear, I find my best strategic thinking about marketing a home or building a winning offer for buyers happens up at Sibley while walking the dogs in the early morning.

Hiking may not be at the top of the list toward the end of this year though--I'm celebrating my next BIG birthday, and we're heading to Paris for art, food, and friends.  

Here's to a great 2017 for us all!