Limiting Taxes On Great Real Estate Investment

Q: We bought a duplex town home 1999 for $105,000, sold it on April 15, 2005 for $428,000.
 

We lived in the home as our primary residence until May 30, 2003.

It sat empty on one side for 18 months and my mother-in-law lived in the other half but we never charged her any rent.

What happens to the proceeds from the sale? When figuring out our profit, can we also claim all the upgrades we did to the property?

We took the cash from the sale and paid off the mortgage to our new home. Should we have done a 1031 tax-free exchange instead? When we do our taxes can we claim all the proceeds or just half of them due to the property being a 2-family home?

A: Having your mother-in-law live rent free does not make your home an investment property. You would have had to have someone else renting the home from you for the two-family building to qualify as a rental property.

That said, did you ever take any rental property deductions? Did you declare the property as a rental property? If not, then it remains your personal residence.

And it sounds as though it was your personal residence for four years, including two of the last five years. Provided that you never declared the property as a part rental, you and your spouse should be able to keep up to $500,000 in profits tax free.

Since your sales price isn't above a half million dollars, you don't need to worry about whether you can claim upgrades.

But if you just want to know, the profit of a house is determined by taking the costs of purchase plus the costs of sale (commissions and transfer taxes, etc.) and adding in any capital improvements (roof, new addition but not paint or decorating) and subtracting this number from the sales price.

It sounds like you're in good shape, but you'll want to run this by your tax advisor or accountant just to make sure you didn't inadvertently take any tax deductions you shouldn't have. And, if you did, you should consult a tax advisor to determine whether you need to refile your income taxes for prior years to remove deductions for the home which should not have been taken.

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