Tax Time: Can You Still Reap Tax-Free Profits?

Taxpayers who sell their principal residence can pocket—tax-free—as much as $500,000 in profit if they file federal taxes jointly or $250,000 if they file singly. The property must have been owned and used as their principal residence for any two of the prior five years that end on the sale date. News Alert - it's Tax Time

Homeowners can shelter the profits on the sale of a home as often as once every two years. If the two-year use and ownership tests are not met, but the home is sold because of special circumstances (i.e., health problem, job loss, etc.), the exclusion is prorated. Otherwise, gains above $500,000 or $250,000 are taxed at current capital gains rates plus may be subject to an additional 3.8% surtax, depending on income.

Some More Complexities

In effect since January 1, 2013, the Net Investment Income Tax (NIIT) applies a 3.8% surtax to certain types of net investment income of individuals, estates and trusts that have modified adjusted gross income (MAGI) exceeding certain thresholds. For individuals, the MAGI threshold for a single filer or a person filing as head of household (with qualifying person) is $200,000; for married filing jointly or for a qualifying widow(er) with a dependent child, $250,000; and for married filing separately, $125,000.

The 3.8% tax is applied to whichever amount is less—your net investment income or the amount your income exceeds the applicable threshold. For example, if a couple’s net investment income is $200,000 while their MAGI is $300,000 ($50,000 above the applicable threshold), the 3.8% tax would be applied to the $50,000 in excess of the threshold.

For home sellers with MAGI above the applicable threshold, the 3.8% tax may be applied to their home-sale gains that exceed their home-sale gain exclusion ($500,000 for married joint filers, $250,000 for single filers). If your MAGI amount above the threshold is less than your un-excluded home-sale gains plus net income from certain other investments, you would only owe the 3.8% tax on the excessive MAGI amount (NIIT applies to the lesser of extra income or extra gains). You can still take either $250,000 or $500,000 in profits from your home sale tax-free.

Income from rental property, gains from the sale of a second home and gains from the sale of an investment property would be considered part of net investment income (and possibly subject to the NIIT) to the extent that gains are not otherwise offset by capital losses.

This is just an introduction to a complex financial topic. For more details on what you can or cannot deduct, consult a qualified financial professional.

Four Steps to Finishing Your Basement

Dehydrate the space

The worst place to hang out is a damp and drippy basement. Inspect your basement first to be sure there are no obvious pools of water or leaks. A few more tests include:

Basement fix up

  • Inspecting for water or insect damage in the structure of the basement.
  • Repairing cracks in the foundation or around pipes; any crack wider than a pencil should be inspected by a structural engineer.
  • Taping squares of plastic sheeting to the ground and walls to see whether moisture builds up in a couple weeks; if it does, check the foundation again.
  • Checking to make sure the ground slopes down and away from your house.
  • Checking the carbon monoxide ventilation system.

Planning your space

Your basement needs the right balance of natural light and darkness for the entertainment space. A lounge should have sunshine, but a TV room should be dark for best viewing.

  • Be wary of adding too many rooms and doors — you don’t want your basement to feel like a string of rooms.
  • Bedrooms must have a window from which to escape in an emergency.
  • If you’re installing a bathroom or lights, be sure plumbing and electrical work is up to code. Indeed, all structural changes may need local approval.

Special rules for basements

With all the extra moisture, coolness and heavy-duty structure in your basement, the same rules aren’t going to apply below ground as they do above when beefing up the walls. Take note of the following guidelines — and make sure your contractor knows the rules, too:

  • A vapor barrier is key to a moisture-free basement; lay it on the walls and floors for a few days, and check for moisture before continuing.
  • Place your vapor barrier and foam insulation over the foundation walls and the stud frame, and install drywall on top of that. Your insulation may come with a vapor barrier on both sides.
  • Mold will grow on standard drywall, so use wall panels meant for basements.

Decorating the results

Once all the behind-the-scenes work is done, the fun part can begin: the interior! Here are some recommendations for a beautiful basement:

  • Consider adding dropped ceilings to provide easy access to electrical and plumbing lines. Check out the options at your local home improvement store; you’ll be surprised by how many handsome options you have.
  • Recessed lighting helps ceilings seem high.
  • Baseboard heating keeps your basement warm, and the rising heat warms upstairs, too.

Leave the space around your HVAC unit and water heaters unfinished so that it follows code. Plan on two to three feet around the equipment for the people who will be inspecting and repairing it.

Once you’ve finished your basement, you’ll feel like you won a marathon. Now you can fill it with your guests, kids and pets — if you allow them in your nice, new area!