Deferring a Home Sale to Next Year Could Reduce Tax Bill

It’s time to close the books on 1994 and to figure out if there’s anything that can be done to minimize your tax bill.

One tip that some politically minded accounting experts suggest is to defer the sale of your home into 1995.

Why? The Republican Party’s so-called “contract with America” has a provision that--if it becomes law--could save some home sellers a great deal of money starting next year on their income taxes. Current law doesn’t allow taxpayers to claim a loss on the sale of their principal residence. For many sellers in the San Fernando Valley, who have watched home prices nose-dive this decade, they have not been able to get any tax relief when they sell their homes at a loss.

But if the Republican Congress has its way, taxpayers who sell their homes next year would get to claim some loss on the sale to offset other income. “This proposal will get a lot of discussion. It’s clearly on the agenda for the first 100 days of the Republican Congress,” said Joseph Knott, partner in charge of the Los Angeles tax practice of the accounting firm Kenneth Leventhal & Co. in Century City.

“It would be prudent for sellers who are losing money to defer their (home) sale to next year,” he said. Of course, it’s not a sure thing that the proposal will become law, but at least it does hold out some hope for sellers who face a loss on their homes. To be safe, Knott advised, home sellers should defer their sale until at least Jan. 3--when Congress reconvenes.

One existing tax advantage for homeowners falls into the arcane category of “casualty losses,” including damage from the Northridge earthquake.

But things are complicated because not all “casualty losses” are tax-deductible.

Indeed, the math on casualty losses is Byzantine, an IRS specialty. That’s because the IRS requires homeowners who suffer a casualty loss to report the lesser of the following: A) the difference between the fair market value of the property just before and just after the earthquake, or B) the “adjusted cost basis”--the real cost--of your residence, minus 10% of your adjusted gross income, plus $100.

The adjusted basis is the purchase price of a home, plus any permanent improvements added while you owned that home. (If you owned a home before and you deferred paying a tax on the profit by buying another home, the adjusted basis of the first home is added into the tax basis of the second home.)

To give one example: Say the Smith family had a Northridge home that was worth $700,000 before the earthquake. But the quake ravaged the place, and its fair market value is now only $300,000. This family lived in their home more than a decade, so the adjusted basis of their home is a modest $120,000.

Although the difference between the “before” and “after” value of their home is a whopping $400,000, for tax purposes, the Smiths can only write off a total casualty loss of $104,900.

Why? This couple has an adjusted gross income of $150,000; after subtracting $15,100 (10% of their adjusted gross income, plus $100) from their $120,000 adjusted cost basis of their home, they wind up with only $104,900 in casualty losses.

More information about the cost basis of your home is available in a free IRS booklet entitled “Tax Information on Selling Your Home.” To get it, call the IRS at (800) TAX-FORM.

And if the Northridge quake left you facing a foreclosure on your home, guess what? You may also owe a capital gains tax.

Much depends on what kind of mortgage you have.

If you still have the original home loan, under state law, this is considered a purchase money loan, or as the trade calls it, a “non-recourse” loan. This prevents the lender from going after you in court to make up any difference between the remaining amount of the loan and what the foreclosed home is now worth. But if you have refinanced your mortgage, chances are you’re not protected by the state law, and in theory, the lender could chase after you to make up the difference.

Keep in mind that you could also owe the IRS a capital gains tax even if your home is now worth less than the property’s mortgage, or if you previously owned another home and sold that at a profit, but deferred that tax by purchasing another home.

So either from the sale or foreclosure of a property, you could owe some capital gains taxes. Therefore, keep your eye on another Republican proposal, in which capital gains taxes could be slashed by 50% starting in 1995.

Alas, as with almost anything involving taxes, the rules are so complicated that it may be advisable to get professional help from a CPA or an attorney familiar with real estate tax issues.