I recently met with Julie, a client of mine, who had just sold her home and downsized into a smaller one. As a result, she had more than $150,000 to invest and wanted some advice on what to invest it in. In situations like these, I have found it helpful to ask some key question to help me design an appropriate recommendation.
One of the first questions I asked Julie was: “How much money will you need for taxes?” Many times clients will have already discussed this with their tax advisor, but in this case, Julie had not. So I asked her how much she had sold her house for, and she said $350,000. I then asked the key question: “How much was your cost basis in the home?”
Her response: “I have no idea.”
I then asked: “How much did you pay for the house?” She went on to explain that her and her then husband purchased the property more than 40 years ago and built a house later that year, but she could not remember for how much. I explained that she would have to report the sale on her income taxes for 2013 and that she would have to pay capital gains taxes on any gain (selling price minus cost basis) above $250,000 (the exemption for a single person).
She did not know what to do, so I called a CPA to get his opinion on the matter. He let us know that if you took the value from the current property tax statement (which Julie had), and discounted that value 2 percent per year, you would come up with a starting basis for the property that would be acceptable to the IRS. He also reminded me to add the cost of any improvements over the years, and I should come up with a “reasonable” cost basis to report.
I did the calculation as he suggested, and we came up with a starting cost basis of $40,000. Had we stopped there, she would have had a gain of $310,000 and a net taxable gain of $60,000 ($310,000 minus $250,000). In her tax bracket, she could have owed $10,000 in taxes or more.
I then asked Julie about the improvements (upgrades, landscaping, additions, etc.) over the years. She let me know that a few years after building the house, they added a very large deck, which cost about $25,000 at the time. Then she remembered adding a bathroom and redoing the kitchen.
By the time we were done, we had come up with more than $140,000 worth of improvements in her 42 years of living in the home. This brought the cost basis up from $40,000 to $180,000, and now her gross gain was $350,000 minus $180,000, or $170,000, which is less than the $250,000 exemption, and therefore, no tax is due.
She was quite relieved and really appreciated me taking the time to help her work through the process.
This was a good example of how full-service financial planners can assist their clients.
Securities and advisory services offered through National Planning Corporation (NPC), Member FINRA/SIPC, a Registered Investment Adviser. Ostrofe Financial Consultants, Inc. and NPC are separate and unrelated companies.
The information in this column does not constitute advice of any kind, including tax advice. Please consult your tax adviser for specific information about your tax situation.
Frederick Fisher is a CFP®, and Insurance Agent. Securities and advisory services offered through National Planning Corporation (NPC), Member FINRA/SIPC, a Registered Investment Adviser. Ostrofe Financial and NPC are separate and unrelated companies. For questions or suggestions, contact Rick Fisher at 530-273-4425, or firstname.lastname@example.org.