Dear MarketWatch,
Before I married my wife, she took out a mortgage on a home in El Paso, Texas so she and her mom could live in it.
After we married, my mother-in-law stayed at the property and made the mortgage payments. She’s not in good health and my wife wants to sell the property. We never profited from the property as I considered it her mom’s home.
The home was purchased for $ 75,000 in 2005, but it was never kept up and it’s been neglected. I’m even afraid to walk in and see the mess. It’s in the process of being vacated and cleaned. A local realtor said they can probably sell it for $ 160,000.
The home is in my wife’s name. The home is not listed in a trust.
Will we be responsible for capital-gains tax? If so, what options do we have to avoid it? Thanks for your insight.
Taxes in Texas
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Dear Taxes,
You have multiple options to explore, assuming you have come to an arrangement with your mother-in-law and her long-term care after she moves out. If the house does sell for as much as the real-estate agent says, you’re looking at a gain of $ 85,000.
If you want to avoid capital-gains tax on the sale of your mother-in-law’s home, the first and most straightforward option: You bite the bullet and live in the home, and not pay the tax man a single cent.
I know it may be an annoyance, but if you live in the house for at least two years, your gains won’t be taxed under existing rules. The Internal Revenue Service says that if you’re married and file taxes jointly, you can exclude up to $ 500,000 of capital gains on real estate.
According to the MarketWatch Tax Guy column: “To qualify for the larger $ 500,000 joint-filer gain exclusion, at least one spouse must pass the ownership test and both spouses must pass the use test. When only one spouse passes both tests, the maximum gain exclusion is only $ 250,000. However, if you and your spouse own two houses, you can each potentially separate $ 250,000 exclusions.”
Not interested in moving in? You can also consider renovating the property and renting it out. Calculate the projected rental income and see if it covers all the expenses you take on to renovate the home, and also see if it adds some additional income to the family.
“It may be worth a discussion to better understand the economics of renting the home,” Matt Sotir, a financial professional with Equitable Advisors, told MarketWatch.
Not interested in renting either? Then you can also consider a 1031 exchange, if it was treated as an investment property and it qualifies. Talk to your real-estate agent and see if this applies, and if it does, you can exchange the property under the 1031 rules, Sotir said. In other words, you can sell the property and use the money to purchase a “like kind” property, he said. And “given the amount of the gain, it may be a complex way to avoid a modest tax,” he added.
But if you just want to get rid of the home as soon as possible, you can likely lower your tax bill simply by including the costs you bore to fix it up. Keep track of all the money you’re spending on the home, if you’re choosing to clean up, repair and/or remodel it.
You can list those costs when you file your taxes, and that may cut (but not defer or completely eliminate) your overall capital-gains tax, because you can subtract these costs from your sales price. Consult a real-estate agent on whether this route makes sense for you.
But a word of caution. Don’t be obsessed with trying to avoid paying the tax man, and then holding onto the home for longer than you want.
“Sometimes, after exploring all options to reduce these taxes, some tax will have to be paid,” Sotir said. “If the house needs to be sold, try to limit the tax liability to the maximum extent possible.”
But he agrees that you should sell the house, if that’s what you all want, “and don’t let the fear of a modest tax stop you.”
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