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Question: I'm thinking to buy my first home and have been looking into mortgage (most likely fixed rate 20 or 30 year) and realize that I'd be paying around 2 x times the loan amount in interest by the time I've paid off my mortgage. I have a brother who could potentially loan me some money to buy the house cash. What kind of a contract could I possibly sign with my brother where he'd at least not loose money (to inflation etc.) over the duration where I'd be paying him back? Little context: I'm 35, steady employment (100K annually), no debt, 780 credit score, want to get a house in greater Seattle area for around 500K with 20% down payment(to avoid mortgage insurance)

Answer:

Exploring Alternatives to Traditional Mortgages: Setting Up a Family Loan

Buying your first home is an exciting milestone, and exploring alternatives to traditional mortgages can be a smart move, especially if you have the opportunity to work with a family member willing to help. Below, I'll outline how you might structure a fair and legally sound loan agreement with your brother, ensuring both parties are protected and benefit from the arrangement.

1. Understanding Family Loans

A family loan is a financial agreement between relatives, in this case, between you and your brother. While it can offer flexibility and potentially better terms than a traditional mortgage, it's important to treat it as a formal business transaction to avoid misunderstandings and potential legal or tax issues.

2. Benefits of a Family Loan

  • Lower Interest Rates: You may secure a lower interest rate than a bank would offer.
  • Flexible Repayment Terms: Terms can be adjusted to fit both parties' needs.
  • Avoidance of Bank Fees: Eliminates origination fees, closing costs, and other bank-related expenses.
  • Investment Opportunity for Lender: Your brother can earn interest income, potentially higher than traditional investments.

3. Structuring the Loan Agreement

a. Determine the Loan Amount and Terms

  • Loan Amount: Approximately \$400,000 (assuming a 20% down payment on a \$500,000 home).
  • Interest Rate: Set a rate that is fair to both parties. Consider the Applicable Federal Rate (AFR) as a minimum to avoid tax complications.
  • Loan Term: Decide on a repayment period (e.g., 15, 20, or 30 years).
  • Payment Schedule: Monthly payments are standard, but you can agree on a different schedule.
  • Amortization: Determine if the loan will be fully amortizing, interest-only for a period, or have a balloon payment.

b. Use a Promissory Note

A promissory note is a legal document outlining the loan terms. It should include:

  • Borrower and Lender Information: Full legal names and contact information.
  • Loan Amount: Principal sum borrowed.
  • Interest Rate: The agreed-upon annual interest rate.
  • Repayment Terms: Payment amounts, due dates, and duration.
  • Default Conditions: What happens if payments are missed.
  • Prepayment Clause: Terms regarding early repayment.

c. Secure the Loan with a Mortgage or Deed of Trust

To protect your brother's interest:

  • Mortgage or Deed of Trust: This legal document secures the loan with the property as collateral.
  • Recording: File the mortgage or deed of trust with the local county recorder's office.
  • Lien Position: Establishes your brother's claim on the property in case of default.

4. Tax Implications

a. For Your Brother (the Lender)

  • Interest Income: Must report interest received as income on his tax return.
  • Below-Market Interest Rates: Charging less than the AFR can result in imputed interest, leading to potential tax consequences.

b. For You (the Borrower)

  • Mortgage Interest Deduction: You may deduct interest paid on the loan if the mortgage is properly secured and recorded.
  • Form 1098: Typically issued by lenders to report mortgage interest; discuss with a tax professional how to handle this.
  • Consult Attorneys: Both parties should seek independent legal advice to ensure the agreement complies with state laws and protects both interests.
  • State Laws: Mortgage laws vary by state; ensure compliance with Washington state regulations.
  • Documentation: Keep thorough records of all payments and communications.

6. Protecting Family Relationships

  • Open Communication: Discuss expectations and what-ifs openly (e.g., late payments, financial hardships).
  • Contingency Plans: Agree on steps to take if unforeseen circumstances arise.
  • Neutral Third Party: Consider using a loan servicing company to handle payments and record-keeping.

7. Alternative Ideas

a. Blend Loan

  • Combination Financing: Part of the loan from your brother, the rest from a traditional lender.
  • Benefits: Reduces the amount you need to borrow from the bank, potentially lowering interest costs while limiting your brother's exposure.

b. Shared Equity Arrangement

  • Co-Investment: Your brother invests in the property in exchange for a percentage of the appreciation upon sale.
  • Agreement Terms: Clearly define ownership percentages, responsibilities, and exit strategies.

c. Gifting Funds

  • Annual Gift Exclusion: Your brother can gift up to \$17,000 per year (as of 2023) without tax consequences.
  • Lifetime Exemption: Larger gifts can apply against the lifetime estate and gift tax exemption.

Note: Gifting has significant tax implications and should be discussed with a tax professional.

8. Steps to Proceed

  1. Assess Affordability

    • Use mortgage calculators to determine comfortable payment amounts.
    • Ensure your budget accommodates the loan without overextending.

  2. Discuss with Your Brother

    • Present a formal proposal outlining terms.
    • Be open to negotiation to reach mutually agreeable terms.

  3. Consult Professionals

    • Financial Advisor: To assess how this fits into both parties' financial plans.
    • Tax Professional: For guidance on tax reporting and implications.
    • Real Estate Attorney: To draft and review legal documents.

  4. Draft Legal Documents

    • Create a promissory note and mortgage or deed of trust.
    • Ensure all documents comply with legal requirements.

  5. Finalize the Agreement

    • Sign documents in the presence of a notary public.
    • Record the mortgage or deed of trust with the county recorder.

  6. Set Up Payment System

    • Loan Servicing Company: Optional but can handle payment processing and record-keeping.
    • Automated Payments: Establish automatic transfers to avoid missed payments.

9. Considerations Before Proceeding

  • Risk Assessment

    • For Your Brother: He should consider the risk of lending a significant sum and the impact on his financial goals.
    • For You: Ensure you can commit to the repayment schedule to avoid straining the relationship.

  • Impact on Credit

    • Positive: Regular, on-time payments can build your credit if reported.
    • Negative: Defaults can harm your credit and personal relationship.

  • Exit Strategy

    • Refinancing: Plan to refinance with a traditional lender in the future if beneficial.
    • Property Sale: Agree on terms if you decide to sell the property before the loan is repaid.

Conclusion

Structuring a family loan with your brother can be a win-win situation if approached thoughtfully and professionally. By formalizing the agreement, considering tax implications, and protecting both parties' interests, you can secure favorable financing for your home purchase while providing your brother with a solid investment opportunity.

Question: Looking for advice to lower our mortgage payment. Have looked into recasting but was unsure how smart this is since the length of the loan doesn’t change. Does the amount of interest change? We would foremost want the monthly payment to be much smaller but it would also be nice to shave off some years as well. I am also aware of paying some principal off by making extra payments but am curious if you can do multiple things if you had some extra money to put down?

Answer:

How to Lower Your Mortgage Payment and Potentially Reduce Your Loan Term

If you're looking to lower your monthly mortgage payment and possibly reduce the length of your loan, you have several options to consider. Let's explore mortgage recasting, refinancing, making extra principal payments, and combining these strategies to help you make an informed decision.

1. Mortgage Recasting

What Is Mortgage Recasting?

Mortgage recasting is a process where you make a lump-sum payment toward the principal balance of your mortgage, and your lender recalculates your monthly payments based on the new, lower balance while keeping the same interest rate and loan term.

Does the Amount of Interest Change?

Yes, the total amount of interest you'll pay over the life of the loan decreases because your principal balance is reduced. However, your loan term remains the same, so while your monthly payments decrease, the interest rate and loan maturity date do not change.

Benefits of Recasting:

  • Lower Monthly Payments: Reduces your required monthly payment due to a lower principal balance.
  • Minimal Fees: Typically involves lower fees compared to refinancing.
  • No Credit Check Needed: Since you're not changing loan terms or interest rates, lenders usually don't require a credit check or appraisal.
  • Interest Savings: You pay less interest over time because the principal is reduced.

Considerations:

  • Loan Term Unchanged: The length of your loan doesn't shorten; you'll still pay over the original term unless you make additional principal payments.
  • Not Universally Available: Not all lenders offer recasting, and some loan types (like FHA or VA loans) may not be eligible.
  • Lump-Sum Requirement: You'll need a significant amount of money to make the lump-sum payment.

2. Refinancing Your Mortgage

What Is Refinancing?

Refinancing involves replacing your existing mortgage with a new one, possibly with a lower interest rate, different loan term, or both.

Benefits of Refinancing:

  • Lower Interest Rate: Can reduce your monthly payment and total interest paid if rates are lower than your current rate.
  • Adjust Loan Term: You can choose a longer term to lower monthly payments or a shorter term to pay off the loan faster.
  • Switch Loan Types: For example, moving from an adjustable-rate mortgage to a fixed-rate mortgage for stability.

Considerations:

  • Closing Costs: Refinancing involves fees such as appraisal, origination, and closing costs.
  • Credit Requirements: You'll need to qualify based on your credit score, income, and debt-to-income ratio.
  • Break-Even Point: It may take time to recoup the costs of refinancing through monthly savings.

3. Making Extra Principal Payments

How Does It Work?

By paying extra toward your mortgage principal, you reduce the outstanding balance faster, which can shorten your loan term and reduce total interest paid.

Benefits:

  • Shorten Loan Term: You can pay off your mortgage earlier than scheduled.
  • Interest Savings: Reduces the amount of interest you pay over the life of the loan.
  • Flexibility: You can make extra payments when you have additional funds without committing to higher regular payments.

Considerations:

  • Monthly Payment Remains the Same: Your required monthly payment doesn't decrease unless you recast or refinance.
  • No Immediate Cash Flow Benefit: Extra payments don't lower your current monthly obligation.
  • Prepayment Penalties: Check if your loan has penalties for paying off the mortgage early.

4. Combining Strategies

Can You Do Multiple Things with Extra Money?

Yes, you can combine strategies to lower your monthly payments and shorten your loan term.

Options:

  • Recast and Make Extra Payments: Make a lump-sum payment to lower your monthly payment through recasting and continue making extra payments to pay off the loan sooner.
  • Refinance to a Shorter Term: Refinance to a loan with a shorter term and potentially a lower interest rate, which may keep payments similar but reduce the loan duration.
  • Refinance After Making a Lump-Sum Payment: Pay down your principal before refinancing to secure better terms and lower payments.

Considerations:

  • Evaluate Costs vs. Savings: Weigh the upfront costs of refinancing or recasting against the long-term savings.
  • Financial Goals: Decide whether lowering your monthly payment or shortening your loan term is more important for your situation.
  • Emergency Funds: Ensure you have sufficient savings before committing extra funds to your mortgage.

5. Other Options to Lower Monthly Payments

a. Loan Modification

  • What Is It? A loan modification adjusts the terms of your existing loan, such as extending the loan term or reducing the interest rate.
  • When to Consider: Typically an option if you're experiencing financial hardship.
  • Impact: Can lower monthly payments but may affect your credit score.

b. Bi-Weekly Payments

  • How It Works: Make half of your monthly payment every two weeks, resulting in an extra full payment each year.
  • Benefits: Can reduce the loan term and total interest paid.
  • Effect on Monthly Payment: Monthly obligation remains the same, but you pay more over the year.

6. Factors to Consider

a. Interest Rates

  • Current Market Rates: Compare your current mortgage rate to prevailing rates to determine if refinancing makes sense.
  • Rate Reduction Threshold: A common guideline is that refinancing is beneficial if you can lower your rate by at least 0.5% to 1%.

b. Loan Terms

  • Remaining Loan Duration: Consider how far you are into your current mortgage term.
  • Future Plans: If you plan to move soon, the costs of refinancing or recasting may not be recouped.

c. Fees and Costs

  • Recasting Fees: Usually minimal, often around $250.
  • Refinancing Costs: Can range from 2% to 5% of the loan amount.

d. Credit Score and Financial Health

  • Credit Impact: Refinancing requires a credit check, and a higher score can secure better rates.
  • Debt-to-Income Ratio: Lenders assess your ability to repay based on your income and existing debts.

7. Steps to Take

a. Contact Your Lender

  • Discuss Recasting: Ask about eligibility, minimum lump-sum requirements, fees, and how it will affect your payment.
  • Explore Refinancing Options: Inquire about current rates, loan terms, and closing costs.

b. Shop Around

  • Compare Lenders: Different lenders may offer better rates or lower fees.
  • Use Online Calculators: Estimate savings from refinancing or recasting using mortgage calculators.

c. Review Your Financial Goals

  • Short-Term vs. Long-Term Savings: Decide whether immediate monthly savings or long-term interest savings are more important.
  • Investment Alternatives: Consider whether investing extra funds elsewhere could yield better returns.

d. Check for Prepayment Penalties

  • Loan Agreement: Review your mortgage documents to ensure there are no penalties for extra payments or early payoff.

8. Conclusion

Choosing the Best Strategy

  • If Lower Monthly Payments Are Priority:

    • Recasting: Effective if you have a lump sum and want immediate reduction in payments without altering your loan term.
    • Refinancing to a Longer Term: Can lower payments but may increase total interest paid over time.

  • If Reducing Loan Term Is Priority:

    • Extra Principal Payments: Helps pay off the loan faster and save on interest.
    • Refinancing to a Shorter Term: May increase monthly payments but reduces overall interest and loan duration.

  • If Both Lower Payments and Shorter Term Are Desired:

    • Combination Strategy: Recast to lower payments and continue making extra principal payments to shorten the loan term.

Question:

My Wife and I(both 33) make around 400-450k a year. A little variable since she’s in sales. I bring home 200k that’s stable.

Our assets:

180k in stocks 80k in high yield savings account&checking Current home 580-610,000 value and paid off All cars are paid off 0 cc debt etc., every month all cards are paid off Idk what either of our 401ks current value are but I will also have a pension of 33% of my salary when I retire @ 50.

New home will be $1,140,000. We’ve currently put down about 200k towards the house in deposits so far.

We are trying to figure out if it makes financial sense to rent our home out or if we should just sell it and either invest or put the money towards the new home. Any advice is appreciated. I know we would be giving up lots of long term gains in the market but I’m currently leaning towards selling and putting at least 450k towards the new home.

Answer:

Evaluating Whether to Rent Out or Sell Your Current Home

Making the decision to rent out or sell your current home involves several financial, tax, and personal considerations. Below is a comprehensive analysis to help you assess which option aligns best with your financial goals and lifestyle preferences.

1. Financial Considerations

a. Equity Utilization

  • Reducing New Mortgage Amount: Selling your current home and applying the proceeds (estimated at \$450,000 after costs) toward your new home reduces your mortgage amount to around \$490,000 (\$1,140,000 – \$200,000 deposit – \$450,000 from sale).
  • Interest Savings: A lower mortgage principal results in significant interest savings over the life of the loan.
  • Monthly Payments: Reduced loan amounts lead to lower monthly payments, increasing your cash flow and financial flexibility.

b. Rental Income Potential

  • Market Rent Analysis: Research the local rental market to estimate potential monthly rental income for your current home.
  • Cash Flow Consideration: Subtract expenses (property management fees, maintenance, taxes, insurance) from rental income to determine net cash flow.
  • Return on Investment: Compare the net rental income against potential returns from alternative investments, such as stock market investments or paying down your new mortgage.

2. Tax Implications

a. Capital Gains Tax Exclusion

  • Primary Residence Exclusion: The IRS allows you to exclude up to \$500,000 of capital gains from the sale of your primary residence if you've lived there for at least 2 of the last 5 years.
  • Timing Matters: Converting your home into a rental property may jeopardize this exclusion if you sell after the exclusion period expires.

b. Rental Property Tax Considerations

  • Rental Income Taxation: Rental income is taxable, but you can deduct expenses like repairs, maintenance, and depreciation.
  • Depreciation Recapture: When you eventually sell a rental property, depreciation deductions you've taken are “recaptured” and taxed as ordinary income.

3. Lifestyle and Management Considerations

a. Being a Landlord

  • Time Commitment: Managing tenants, maintenance issues, and legal obligations can be time-consuming.
  • Stress Factors: Dealing with late payments, property damage, or vacancies can add stress.
  • Property Management Companies: Hiring a management company can alleviate some burdens but will reduce your net income due to management fees.

b. Peace of Mind

  • Financial Simplicity: Selling simplifies your finances, allowing you to focus on your new home and other investments.
  • Risk Reduction: Eliminates risks associated with property management and real estate market fluctuations.

4. Market Conditions and Investment Strategy

a. Real Estate Market Outlook

  • Current Market Value: With your home's value between \$580,000 and \$610,000, assess whether the market is favorable for sellers.
  • Future Appreciation: Consider the potential for property value growth in your area if you retain the home.

b. Investment Diversification

  • Asset Allocation: Evaluate how owning additional real estate fits into your overall investment portfolio.
  • Alternative Investments: Selling the home provides capital that can be invested in diversified assets, potentially yielding higher returns.

5. Financial Projections

a. Mortgage Comparison

  • With Sale Proceeds Applied:

    • Mortgage Amount: Approximately \$490,000
    • Lower Monthly Payments: More manageable and less financial strain.
    • Interest Savings: Significant reduction in total interest paid over the loan term.

  • Without Sale Proceeds Applied:

    • Mortgage Amount: Approximately \$940,000
    • Higher Monthly Payments: Greater financial commitment.
    • Interest Costs: Increased total interest over the life of the loan.

b. Opportunity Cost

  • Investing Sale Proceeds: If not applied to the new home, consider potential returns from investing the \$450,000 in stocks or other assets.
  • Comparative Analysis: Weigh the potential investment returns against the interest savings from a reduced mortgage.

6. Personal Goals and Future Plans

a. Retirement Planning

  • Early Retirement: With a pension starting at age 50, reducing debt now can enhance your financial independence later.
  • Cash Flow Needs: Lower monthly obligations increase your ability to save and invest for retirement.

b. Family and Lifestyle

  • Stability: Owning one primary residence simplifies your lifestyle.
  • Flexibility: Financial liquidity offers more options for future opportunities or unexpected expenses.

Conclusion and Recommendations

Based on the information provided and your inclination for peace of mind, selling your current home and applying the proceeds toward your new home seems to be a financially sound decision. This approach offers:

  • Debt Reduction: Significantly lowers your new mortgage amount and monthly payments.
  • Interest Savings: Reduces the total interest paid over the life of the loan.
  • Simplification: Avoids the complexities and responsibilities of being a landlord.
  • Tax Benefits: Allows you to capitalize on the primary residence capital gains tax exclusion.

Next Steps

  1. Consult Financial Professionals:

    • Financial Advisor: To evaluate how this decision fits within your overall financial plan and retirement goals.
    • Tax Professional: To understand any tax implications and ensure you maximize available deductions and exclusions.

  2. Conduct a Market Analysis:

    • Real Estate Agent: Obtain a comparative market analysis to determine the optimal listing price for your current home.
    • Timing: Assess whether current market conditions favor selling now.

  3. Review Mortgage Options:

    • Lender Discussions: Explore mortgage products that align with your down payment and financial situation.
    • Interest Rates: Lock in favorable rates to maximize savings.

  4. Plan for Future Investments:

    • Diversify: Consider allocating some savings to diversify your investment portfolio.
    • Retirement Accounts: Maximize contributions to your 401(k)s and consider other retirement savings vehicles.

Final Thoughts

Your strong financial position, with stable high income and no significant debts, provides you with flexibility. Prioritizing peace of mind and financial simplicity appears to align with your personal and financial goals. Selling your current home to reduce your new mortgage debt is a prudent move that can enhance your financial well-being in the long term.

Question: I am a legal immigrant in the US working in industry. I made some investments and had substantial profits this year. I would like know what are some ways for legal immigrants to save taxes besides contributing to IRA or HSA etc.

Answer: Saving on taxes in the United States involves strategic planning and understanding the various avenues available to reduce your taxable income legally. Since you've already considered contributing to IRAs and HSAs, here are some additional strategies that might help you minimize your tax liability:

  1. Tax-Loss Harvesting:

    • What it is: Selling investments that have declined in value to offset capital gains from profitable investments.
    • Benefit: Reduces your overall taxable capital gains, potentially lowering your tax bill.

  2. Maximize Employer-Sponsored Retirement Plans:

    • 401(k) or 403(b) Contributions: Increase your pre-tax contributions to these plans, which reduces your taxable income.
    • Employer Match: Ensure you're contributing enough to receive any employer matching funds—it's essentially free money.

  3. Charitable Contributions:

    • Donating Cash or Assets: Gifts to qualified charities can be deducted if you itemize deductions.
    • Donating Appreciated Securities: Donate stocks or mutual funds that have increased in value to avoid capital gains taxes and receive a deduction for the full market value.

  4. Invest in Municipal Bonds:

    • Tax-Free Interest: Interest income from municipal bonds is generally exempt from federal income tax and possibly state and local taxes.
    • Considerations: Assess the credit quality of the issuing municipality and compare the after-tax yield to taxable alternatives.

  5. Hold Investments for Long-Term Capital Gains:

    • Lower Tax Rates: Assets held for more than one year qualify for long-term capital gains rates, which are lower than short-term rates.
    • Strategic Selling: Plan the timing of asset sales to benefit from these lower rates.

  6. Utilize 529 College Savings Plans:

    • Education Savings: Contributions grow tax-free when used for qualified education expenses.
    • State Tax Benefits: Some states offer tax deductions or credits for contributions to the plan.

  7. Consider Health Flexible Spending Accounts (FSAs):

    • Pre-Tax Contributions: Reduce your taxable income by contributing pre-tax dollars to an FSA for medical expenses.
    • Use-It-or-Lose-It: Be mindful of contribution limits and deadlines to avoid forfeiting unused funds.

  8. Real Estate Investment and Deductions:

    • Mortgage Interest Deduction: Deduct interest paid on a mortgage for your primary residence.
    • Property Taxes: Deduct state and local property taxes, subject to limits.
    • Depreciation and Expenses: If you own rental property, you can deduct depreciation and other expenses related to property management.

  9. Energy-Efficient Home Improvements:

    • Tax Credits: Federal tax credits are available for certain energy-efficient upgrades, such as solar panels or energy-efficient windows and appliances.
    • Long-Term Savings: Reduce utility bills while benefiting from tax incentives.

  10. Establish a Donor-Advised Fund:

    • Front-Load Donations: Make a large charitable contribution in one year to a donor-advised fund to maximize deductions when you have higher income.
    • Future Giving: Recommend grants over time to your favorite charities.

  11. Income Timing Strategies:

    • Delay Income: If possible, defer bonuses or other income to the following tax year if you expect to be in a lower tax bracket.
    • Accelerate Deductions: Pay deductible expenses, like medical bills or property taxes, before the end of the year to increase deductions.

  12. Foreign Tax Credits:

    • Claim Credits: If you've paid taxes on foreign investments, you may be eligible for a credit against your U.S. tax liability.
    • Avoid Double Taxation: This ensures you're not taxed twice on the same income.

  13. Business Expenses and Deductions:

    • Side Business: If you have a side business or freelance work, you can deduct related expenses.
    • Home Office Deduction: Deduct a portion of your home expenses if you use part of your home exclusively for business.

  14. Tax-Advantaged Investments:

    • Deferred Annuities: Taxes on earnings are deferred until withdrawal.
    • Life Insurance: Certain life insurance policies accumulate cash value on a tax-deferred basis.

  15. Review Filing Status and Dependents:

    • Marital Status: Your filing status can significantly impact your tax liability.
    • Dependents: Claiming eligible dependents can provide additional exemptions and credits.

Important Considerations:

  • Stay Informed on Tax Law Changes: Tax laws can change annually, affecting deductions, credits, and income thresholds.
  • Documentation: Keep thorough records of all transactions, contributions, and receipts to substantiate your claims.

Question: My husband and I might soon be moving for a job opportunity and will need to sell our house. We have been living in it for close to one year. Based off of the Zillow value I think we would make a small profit. We do want to purchase where we will be moving but it might not be immediately since this area is more expensive. How can we avoid paying taxes if we make a profit? We hope to use this towards a new home purchase (might just not be immediately)

Answer:

Understanding Capital Gains Tax on Home Sales and How to Minimize It

When you sell your primary residence in the United States, the profit you make—known as capital gains—may be subject to taxation. However, the IRS provides certain exclusions that can help you avoid paying capital gains tax on some or all of your profit.

Primary Residence Exclusion

The IRS allows homeowners to exclude up to:

  • $250,000 of capital gains if you're single.
  • $500,000 of capital gains if you're married and filing jointly.

To qualify for this exclusion, you generally must meet both the ownership and use tests:

  1. Ownership Test: You owned the home for at least 2 years out of the 5 years preceding the sale.
  2. Use Test: You lived in the home as your primary residence for at least 2 years out of the 5 years preceding the sale.

Since you've lived in your home for close to one year and are moving due to a job opportunity, you might not meet the full 2-year requirement. However, the IRS provides a partial exclusion for homeowners who sell their home due to a change in employment, health reasons, or unforeseen circumstances.

Eligibility for Partial Exclusion:

  • Change in Place of Employment: If your new job location is at least 50 miles farther from your home than your previous job location was, you may qualify.

Calculating the Partial Exclusion

The partial exclusion is proportional to the time you owned and lived in the home. Here's how to calculate it:

  1. Determine the Shorter of:

    • The period you owned the home.
    • The period you used the home as your main residence.
    • The time between the last sale of a home for which you took an exclusion and the sale of this home.

  2. Calculate the Fraction:

    • Divide the number of months you met the ownership and use tests by 24 months.

  3. Apply the Fraction to the Maximum Exclusion:

    • Multiply the fraction by the maximum exclusion ($500,000 for married filing jointly).

Example Calculation:

  • Months Owned and Lived In Home: 12 months
  • Fraction: 12 months / 24 months = 0.5
  • Partial Exclusion Amount: 0.5 x $500,000 = $250,000

In this example, you could exclude up to $250,000 of the gain from your taxable income.

Steps to Take

  1. Document Your Move:

    • Keep records of your job offer, employment contract, or any other documentation proving the move is job-related.

  2. Report the Sale on Your Tax Return:

    • Even if you exclude all the gain, you may need to report the sale on Form 8949 and Schedule D.

  3. Consult IRS Publication 523:

    • This publication provides detailed guidance on selling your home and calculating exclusions.

Considerations

  • Timing of New Home Purchase:

    • Under current tax laws, you don't need to reinvest the proceeds into a new home to qualify for the exclusion.

  • State Taxes:

    • Check if your state conforms to federal rules regarding capital gains exclusions on home sales.

Question: My husband and I might soon be moving for a job opportunity and will need to sell our house. We have been living in it for close to one year. Based off of the Zillow value I think we would make a small profit. We do want to purchase where we will be moving but it might not be immediately since this area is more expensive. How can we avoid paying taxes if we make a profit? We hope to use this towards a new home purchase (might just not be immediately)

Answer:

Understanding Capital Gains Tax on Home Sales and How to Minimize It

When you sell your primary residence in the United States, the profit you make—known as capital gains—may be subject to taxation. However, the IRS provides certain exclusions that can help you avoid paying capital gains tax on some or all of your profit.

Primary Residence Exclusion

The IRS allows homeowners to exclude up to:

  • $250,000 of capital gains if you're single.
  • $500,000 of capital gains if you're married and filing jointly.

To qualify for this exclusion, you generally must meet both the ownership and use tests:

  1. Ownership Test: You owned the home for at least 2 years out of the 5 years preceding the sale.
  2. Use Test: You lived in the home as your primary residence for at least 2 years out of the 5 years preceding the sale.

Since you've lived in your home for close to one year and are moving due to a job opportunity, you might not meet the full 2-year requirement. However, the IRS provides a partial exclusion for homeowners who sell their home due to a change in employment, health reasons, or unforeseen circumstances.

Eligibility for Partial Exclusion:

  • Change in Place of Employment: If your new job location is at least 50 miles farther from your home than your previous job location was, you may qualify.

Calculating the Partial Exclusion

The partial exclusion is proportional to the time you owned and lived in the home. Here's how to calculate it:

  1. Determine the Shorter of:

    • The period you owned the home.
    • The period you used the home as your main residence.
    • The time between the last sale of a home for which you took an exclusion and the sale of this home.

  2. Calculate the Fraction:

    • Divide the number of months you met the ownership and use tests by 24 months.

  3. Apply the Fraction to the Maximum Exclusion:

    • Multiply the fraction by the maximum exclusion ($500,000 for married filing jointly).

Example Calculation:

  • Months Owned and Lived In Home: 12 months
  • Fraction: 12 months / 24 months = 0.5
  • Partial Exclusion Amount: 0.5 x $500,000 = $250,000

In this example, you could exclude up to $250,000 of the gain from your taxable income.

Steps to Take

  1. Document Your Move:

    • Keep records of your job offer, employment contract, or any other documentation proving the move is job-related.

  2. Report the Sale on Your Tax Return:

    • Even if you exclude all the gain, you may need to report the sale on Form 8949 and Schedule D.

  3. Consult IRS Publication 523:

    • This publication provides detailed guidance on selling your home and calculating exclusions.

Considerations

  • Timing of New Home Purchase:

    • Under current tax laws, you don't need to reinvest the proceeds into a new home to qualify for the exclusion.

  • State Taxes:

    • Check if your state conforms to federal rules regarding capital gains exclusions on home sales.