Q: We purchased a new home in 2013 and understand that we should be OK in regards to capital gains taxes on the sale of our old home. We also, however, sold a lot in a separate location that we at one time were planning to build on. We know we have to pay capital gains tax on this sale, but we are wondering if we are allowed to expense out items such as broker fees, HOA dues (that we paid for 14 years) and other miscellaneous costs like mowing that was required by the HOA.
A: You are correct that you will need to pay capital gains tax on the lot you sold since the lot will not fall under the personal residence exemption I wrote about a few weeks ago. The gain will be calculated as the difference between the selling price and your “adjusted basis” in the land. The selling prince is normally easy to determine since it is the agreed upon price that appears as the first line on the HUD-1 closing statement. You will also receive a 1099-S, Proceeds from Real Estate Transaction, that will report this sale price amount to you and to the IRS. The adjusted basis amount is more difficult to determine and is governed by hundreds if not thousands of pages of tax code, regulations, rulings, and court cases.
Like any investment or property you sell, your adjusted basis is equal to your original cost of the property, plus the cost of improvements you have made, plus all the expenses of purchasing and selling the property. You can find these expenses on the settlement sheets from the purchase and the sale closings. You are also allowed to increase your basis for otherwise deductible expenses that you have previously elected to not deduct, but instead have elected to add to your basis. There is a special annual written election you may have made in your tax return to capitalize the real estate taxes and interest, instead of deducting them each year.
Unfortunately these rules can be very complicated and confusing. Certainly the broker’s fees and other costs of purchasing and selling the property, such as title fees and legal fees, can be added to your basis. Property taxes and interest on debt secured by the property that you have not deducted previously under the special annual written election would add to basis also, but the homeowner association dues and maintenance expenses would not since they are not normally deductible for land held for personal residential use.
You will need to analyze all the expenses related to the property to determine what you can add to basis and what is not allowable. This is never a fun task, but hopefully the time you spend will pay off in a lower tax bill.
Q: My husband has archived boxes of crumpled receipts that he says must be kept in storage for about six years. I love to throw things away and long to ditch those annoying boxes. Now that people can save things electronically, do they need to save hard copies? Have any companies stepped in with novel ways to save receipts efficiently?
A: The IRS still requires that you support what you put on your tax return, but the IRS doesn’t normally require original paper copies. Some of my clients just scan their relevant documents and shred the paper, although keeping originals of signed contracts and other legal papers is always a good idea. I am a little old fashioned in some ways and I do keep my paper documents for six years (our firm policy is seven years for supporting documents stored electronically). Each year as I store my current tax information I pull out the oldest year’s information and destroy it. But that is just my system, not the only system.
I am now in the habit of only keeping what is relevant to the tax return, not every statement and receipt I received during the year like I once did. That has significantly reduced my storage space. In fact the total of all my personal support documents fits in a large envelope and six years can be packed into one box or file cabinet drawer. Of course, I am a simple guy with relatively simple personal finances. I do keep tax returns indefinitely, although they are all electronic now so I don’t have paper copies. I have personally been audited by the IRS and the copied documents were sufficient to receive my “no change” letter.
There are companies that sell special scanners that are supposed to organize your life. I think it is just as easy to scan and save documents in a folder on your computer (with back-up), but then I have never actually used one of the “Only-On-TV” scanners. Let me know if you try one and how it works.