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Rules on carrying a note to help sell a house

Jim HamillALBUQUERQUE, N.M. — Q: My wife and I have listed our home of 19 years, and we have an offer that is conditioned on our carrying back some of the purchase cost. The proposal is a 5-year note that will be amortized as if it were 30 years, and there is a single payment at the end of the 5 years for the balance due on the note. We are debating whether we should wait for a cash offer or simply take this one. We want to retire in Virginia, and the sale will allow us to move on more quickly. But my questions are tax ones. First, I want to confirm that the new tax law did not change the rule that you can sell your main house and not pay tax on the gain. Second, I want to be sure that if we take a note that the tax answer will not change, including if they change the law within the next 5 years to make selling a house less attractive.

A: You can still sell a principal residence and exclude as much as $500,000 of gain. The basic provisions of this law have not changed in the 22 years since it was enacted.

The house must have been your principal residence for 2 of the 5 years before sale. If you both meet this requirement, then your gain exclusion can be as much as $500,000.

The full exclusion also is unavailable if you claimed depreciation for business or investment use of the house, including an office in home. In such a case, you need only report the depreciation as income.

Any rental that occurred after 2008 can require an allocation of gain between a non-excluded investment portion and an excluded residence portion. There is also a special provision if the property was replacement property in a like-kind exchange, but that would not apply to you.

So if there was nothing but personal use of this house, and it was your main home, the entire gain is excluded unless it exceeds $500,000.

The note will either have to call for interest or the tax law will “impute” interest. The interest will be reported as income by you, and it cannot be excluded.

When real estate is sold in New Mexico, the closing is typically done at a title company. That title company is called a real estate reporting person, and it must issue the seller a Form 1099 that reports the gross sales price. This then allows the IRS to ensure the sale is reported on the tax return.

When the exclusion-of-gain provision was passed in 1997, Congress allowed the Treasury Department to set forth rules that would allow a reporting party to not issue a 1099 form if it was known that the gain was all excluded.

The tile company should ask that you certify that the property was never held for investment or business use. If the gross sales price is $500,000 or less the title company can then (legally) not issue a Form 1099 to you.

If there is no form 1099, the sale of the home does not need to be reported by you. If there is a 1099, then the sale should be reported, with an indication that the “Section 121 exclusion” applies so that no gain is reported.

Sales with payments over several years are usually reported to the IRS on Form 6252. This form allows the gain to be spread over the years in which payments are received. A seller can always choose to instead report all gain in the first year.

If you qualify for the gain exclusion with no limits, you will not need to file the Form 6252 because there is no gain to report. In effect, you are electing out of the special reporting by reporting all gain (zero) in the first year.

You will need to report the annual interest on IRS Schedule B. You can just name it “Buyer note,” using the buyer’s name, or some similar designation.

Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

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