What Most People Don’t Know About Principal Residences (But Should) – Part 1

This week I had a discussion with a client about what would happen when either he or his wife passed away. 

During the discussion I learned that his condo was purchased in 1993 for about $100,000 and was now worth about $300,000.  He also has a lake “cabin” he acquired in 1970 for $10,000 plus he spent another $10,000 in building the cabin the following year.  The cabin is currently appraised at over $700,000.

I asked him to tell me about what happened in 1993 when he sold is previous home and purchased the condo.  He told me about using the proceeds from the sale of the house as down payment on the condo ….  I then asked what he reported on his tax return in 1993 regarding the sale.  He was puzzled – he had sold his principal residence so nothing had to be done on his tax return.

This is a common misconception about the principal residence exemption – that your home is exempt and you don’t have to do anything when you sell it.  That is often true – but only if your home is the only residence you own.  In the case of this couple, they owned two properties that qualify for the principal residence exemption.

By not reporting the sale of a principal residence, you are implicitly designating it as your principal residence.  In this case, all homes that the couple sold since 1971 were implicitly designated as their principal residence by virtue of them not reporting the dispositions.  While it’s possible that this was indeed the best choice, the general rule is that, if you own more than one residence, you should determine the fair market value of the residence that is not sold each time the other residence is sold and designate the property that shows the greatest gain.

What information do I need to determine the tax liability if this couple were to expire tomorrow?  I need the value of both properties today, whether the capital gains exemption was claimed on the cottage in 1994, plus:

• the value of the cottage in 1971 (when capital gains became taxable);
• the costs of any improvements made to both properties; and
• the cost of the condo when purchased in 1993.

For Next Week:

Given the following answers, determine the taxable capital gain this couple would have to report in 2015:

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