Business

Sell Your Home But Keep the Profits

With the real estate market looking up in many areas, money is out there to be made. Sellers, it’s time to take a close look at the exclusion rules and cost basis of your home to reduce your taxable gain.

The IRS home sale exclusion rule now allows an exclusion of a gain up to $250,000 for a single taxpayer or $500,000 for a married couple filing jointly. This exclusion can be used over and over during your lifetime, unlike the previous one-time exemption, as long as you meet the following Ownership and Use tests.

During the 5-year period ending on the date of the sale, you must have:

Owned the house for at least two years – Ownership Test
Lived in the house as your main home for at least two years – Use Test

Tip: The Ownership and Use periods need not be concurrent. Two years may consist of a full 24 months or 730 days within a 5-year period. Short absences, such as for a summer vacation, count in the period of use. Longer breaks, such as a 1-year sabbatical, do not.

If you own more than one home, you can exclude the gain only on your main home. The IRS uses several factors to determine which home is a principal residence: place of employment, location of family members’ main home, mailing address on bills, correspondence, tax returns, driver’s license, car registration, voter registration, location of banks you use, and location of recreational clubs and religious organizations you belong to.

Tip: As we said, the exclusion can be used repeatedly, every time you reestablish your primary residence. When you do change homes, let us know your new address so we can ensure the IRS has your current address on file.

Note: Only taxable gain on the sale of your home needs to be reported on your taxes. Further, loss on the sale of your main home cannot be deducted. Ask us for details.

Improvements Increase the Cost Basis

Additionally, when selling your home, consider all improvements made to the home over the years. Improvements will increase the cost basis of the home and thereby reduce the capital gain.

Additions and other improvements that have a useful life of more than one year can be added to the cost basis of your home.

Examples of Improvements
Examples of improvements include: building an addition; finishing a basement; putting in a new fence or swimming pool; paving the driveway; landscaping; or installing new wiring, new plumbing, central air, flooring, insulation, or security system.

Example: The Kellys purchased their primary residence in 1999 for $200,000. They paved the unpaved driveway and added a swimming pool, among other things, for $75,000. The adjusted cost basis of the house is $275,000. The house is then sold in 2011 for $550,000. It costs the Kellys $40,000 in commissions, advertising, and legal fees to sell the house.

These selling expenses are subtracted from the sales price to determine the amount realized. The amount realized in this example is $510,000. That amount is then reduced by the adjusted basis (cost plus improvements) to determine the gain. The gain in this case is $235,000. After considering the exclusion, there is no taxable gain on the sale of this primary residence and, therefore, no reporting of the sale on the Kelly’s 2011 personal tax return.

Tip: Home Energy Credit. Home energy-efficiency tax credits were extended into 2011 at reduced limits and with modifications. A tax credit of 10% of cost up to $500 is available for projects including energy-efficient heating and air-conditioning systems, roofing, and insulation. Further limitations do exist for certain items. For example, for the replacement of windows and skylights, the credit is 10% of cost, capped at $200. But you can still take advantage of tax credits at 30% of cost for alternative energy projects, including geothermal and solar projects and wind turbines. Please contact us for further information on these credits.

Partial Use of the Exclusion Rules

If you do not meet the Ownership and Use tests, you may be allowed to exclude a portion of the gain realized on the sale of your home if you sold your home because of health reasons, a change in place of employment, or certain unforeseen circumstances. Unforeseen circumstances include, for example, divorce or legal separation, natural or man-made disasters resulting in a casualty to your home, or an involuntary conversion of your home.

Example: If you get divorced after living in your home for approximately 1 1/2 years or 438 days and have a gain of $120,000 on the sale of your home, you can take 60% of the capital gain exclusion, as you lived in the house for 60% of the 2-year exclusion period (438 days divided by 730 days, or 60%). Therefore, you would be allowed to deduct $150,000 of the capital gain (60% of the $250,000 exclusion). You would NOT need to report any gain on this sale.

Recordkeeping

Good recordkeeping is essential for determining the adjusted cost basis of your home. Ordinarily, you must keep records for 3 years after the filing due date. However, keep records proving your home’s cost basis for as long as you own your house.

The records you should keep include:

Proof of the home’s purchase price and purchase expenses
Receipts and other records for all improvements, additions, and other items that affect the home’s adjusted cost basis
Any worksheets or forms you filed to postpone the gain from the sale of a previous home before May 7, 1997

Questions?

Tax considerations can be confusing. If you have any questions on taxes related to the sale of your home, give us a call.

The Best Financial Tool for Business Owners

If there were a tool that helped you create crystal-clear plans . . . that provided you with continual feedback on how well your plan was working . . . that told you exactly what’s working and what isn’t, allowing you to consistently make smart business decisions to keep your business on track for success – wouldn’t you want to take advantage of it?

Well, there is such a tool. It’s called the Budget vs. Actual report.

Clarifying Your Plan

Clarity is power. The clearer you are with your business goals, the more likely you are to achieve them.

Creating a budget forces you to drill down in to the details of your goals. It prods you to think about how one business decision affects all other aspects of the company’s operations.

Example: Say you want to grow your sales by 15% this year. Does that mean you need to hire another salesperson? When will the business start to see new sales from this person? Do you need to set up an office for them? New phone line? Buy them a computer? Do you need to do more advertising? How much more will you spend? When will you see the return on your advertising expenditure?

You see, a budget is really a planning tool that makes you clarify your dreams. And planning is the first step in making your dreams real.

Navigating the Ship

Once you’ve clarified your goals, you start making business decisions to help you reach your desired outcome. Some of those decisions will be great and give you better than expected results. And some decisions will give you poor results.

This is where the Budget vs Actual shines.

When you compare your budgeted sales and expenses to your actual results, you see exactly how far you are off your plan. Sometimes you need to adjust your plan (budget) and sometimes you need to focus more attention to the areas of your business that are not performing as well as you planned.

Either way, you are gleaning valuable insights into your business.

It’s like sailing a boat. You are off-course most of the time – but having a clear goal and making many adjustments helps you reach your destination.

Just Do It

Nike knows the power of the phrase “Just Do It.” We often know what we need to do but don’t take the necessary action.

It may seem like a huge hassle to create a budget and then create a Budget vs. Actual report every month. But as with any new skill, although it’s hard at first, it does get easier.

Let us help you. We can guide you through the budgeting process. We can ask you questions that help you gain clarity.

You’ll feel energized after it’s done. You may even have fun.

So “just do it.” Give us a call and we’ll help you turn your dreams into reality.

A SIMPLE Retirement Plan for the Self-Employed

Of all the retirement plans available to small business owners, the SIMPLE plan is the easiest to set up and the least expensive to manage.

These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE plans work well for small business owners who don’t want to spend time and high administration fees associated with more complex retirement plans.

SIMPLE plans really shine for self-employed business owners. Here’s why…

Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings.

SIMPLEs calculate contributions in two steps:

1. Employee out-of-salary contribution
The limit on this “elective deferral” is $11,500 in 2011, after which it can rise further with the cost of living.

Catch-up. Owner-employees age 50 or over can make a further $2,500 deductible “catch-up” contribution as employee in 2011.

2. Employer “matching” contribution
The employer match equals a maximum of 3% of employee’s earnings.

Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $11,500 as employee plus a further $2,500 employee catch-up contribution, plus $1,200 (3% of $40,000) employer match, or a total of $15,200.

SIMPLE plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.

If living expenses are covered by your day job (or your spouse’s job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE retirement investments.

A Truly Simple Plan

A SIMPLE plan is easier to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules – in investment options, spousal rights, creditors’ rights – don’t have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible. Your plan’s custodian, typically an investment institution, has the reporting duties. And the process for figuring the deductible contribution is a bit simpler than with other plans.

What’s Not So Good About SIMPLEs

Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE retirement plan.

Example: If you are under 50 with $50,000 of self-employment earnings in 2011, you could contribute $11,500 as employee to your SIMPLE plus a further 3% of $50,000 as an employer contribution, for a total of $13,000. In contrast, a Keogh 401(k) plan would allow a $25,500 contribution.

With $100,000 of earnings, it would be a total of $14,500 with a SIMPLE and $35,500 with a 401(k).

Because investments are through an IRA, you’re not in direct control. You must work through a financial or other institution acting as trustee or custodian, and you will in practice have fewer investment options than if you were your own trustee, as you would be in a Keogh.

It won’t work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE plan effective for a year, it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE must be set up as soon thereafter as administratively feasible.

If the SIMPLE plan is set up for a sideline business and you’re already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE and the 401(k) combined (in 2011) can’t be more than $16,500 or $21,500 if catch-up contributions are made to the 401(k) by someone age 50 or over.

So someone under age 50 who puts $8,000 in her 401(k) can’t put more than $8,500 in her SIMPLE in 2011. The same limit applies if you have a SIMPLE while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).

How to Get Started with a SIMPLE Plan

You can set up a SIMPLE account on your own, but most people turn to financial institutions.

SIMPLES are offered by the same financial institutions that offer IRAs and Keogh master plans.

You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement you will choose an “effective date” – the beginning date for payments out of salary or business earnings. That date can’t be later than October 1 of the year you adopt the plan, except for a business formed after October 1.

Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.

Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.

Keoghs, SEPs, and SIMPLES Compared

Keogh	SEP	SIMPLE
Plan type: Can be defined benefit or defined contribution (profit sharing or money purchase)	Defined contribution only	Defined contribution only
Number you can own: Owner may have two or more plans of different types, including an SEP, currently or in the past	Owner may have SEP and Keoghs	Generally, SIMPLE is the only current plan
Due dates: Plan must be in existence by the end of the year for which contributions are made	Plan can be set up later – if by the due date (with extensions) of the return for the year contributions are made	Plan generally must be in existence by October 1 of the year for which contributions are made
Dollar contribution ceiling (for 2011): $49,000 for defined contribution plan; no specific ceiling for defined benefit plan	$49,000	$23,000
Percentage limit on contributions: 50% of earnings for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan.	50% of earnings (100% of earnings after contribution). Elective deferrals in SEPs formed before 1997 not subject to this limit.	100% of earnings, up to $11,500 (for 2011) for contributions as employee; 3% of earnings, up to $11,500, for contributions as employer
Deduction ceiling: For defined contribution, lesser of $49,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings.	Lesser of $49,000 or 25% of eligible employee’s compensation. Elective deferrals in SEPs formed before 1997 not subject to this limit.	Same as percentage ceiling on SIMPLE contribution
Catch-up contribution age 50 or over: Up to $5,500 in 2011 for 401(k)s	Same for SEPs formed before 1997	Half the limit for Keoghs and SEPs (up to $2,750 in 2011)
Prior years’ service can count in computing contribution	No	No
Investments: Wide investment opportunities. Owner may directly control investments.	Somewhat narrower range of investments. Less direct control of investments.	Same as SEP
Withdrawals: Some limits on withdrawal before retirement age	No withdrawal limits	No withdrawal limits
Permitted withdrawals before age 59 1/2 may still face 10% penalty	Same as Keogh rule	Same as Keogh rule except penalty is 25% in SIMPLE’s first two years
Spouse’s rights: Federal law grants spouse certain rights in owner’s plan	No federal spousal rights	No federal spousal rights
Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE.	Same as Keogh rule	Rollover after 2 years to another SIMPLE and to plans allowed under Keogh rule
Some reporting duties are imposed, depending on plan type and amount of plan assets	Few reporting duties	Negligible reporting duties

Please contact us if you are a business owner interested in exploring retirement plan options, including SIMPLE plans.