Did you move to Florida while maintaining your residence in another state with plans to one day downsize that residence? If so, you might want to sell your northern residence sooner rather than later to get the Section 121 exclusion from income for the sale of your primary residence.
Many retire to Florida to enjoy our great weather and outdoor activities, but most of all to avoid paying state income tax. Because children and grandchildren reside up north, those same individuals tend to maintain two residences, one here that becomes the primary residence for tax purposes, and the other in their former home state.
The residence up north might be the one where they raised their family. It might be larger than necessary, so the intent is to downsize. But there’s a massive income tax exclusion at risk. If a couple sells a residence that was their primary residence for two years of the past five-year period ending on the date of sale, they exclude $500,000 of the gain from their income. An individual taxpayer excludes $250,000. (See Internal Revenue Code Section 121.)
Assume, for example, that John and Jane Smith resided at a residence in Needham, Massachusetts beginning in 1995, purchasing a home there for $500,000. They bought a home in Florida in 2015 and filed for homestead on January 1, 2019 making Florida their primary residence. They sold the Needham residence for $1.3 million on December 1, 2021. The Smiths qualify for the $500,000 exclusion from income since the Needham residence was their primary for at least two years of the past five dating back to December 1, 2016.
If the Smiths wait until June 30, 2022, they wouldn’t qualify for the exclusion, because going back five years takes them to June 2017 and they declared Florida their primary residence on January 1, 2019. Consequently, the Needham residence was the primary only for 18 months during that time.
As you can readily determine, the clock is ticking on this exclusion from the time that one declares Florida residency. What if you don’t want to sell the home right away? Are there options? Yes, of course there are!
You can establish an irrevocable trust with a separate tax identification number benefiting your children, and they can purchase the residence from you within the qualifying time period. You would want to record a note and mortgage, and for the time that you use the residence you would want to pay fair market value rent (that can offset the trust’s carrying costs of the residence.) When the residence is ultimately sold to a third party, the note and mortgage would be satisfied at closing.
I’m leaving out details to the transaction that would be necessary to qualify for the exclusion, as that’s not the point of this column and I don’t have enough space to examine them all, but you get the picture.
Now is actually a good market for sellers. If you thought about pulling that trigger, keep in mind the Section 121 exclusion on the sale of primary residence.
© 2021 Craig R. Hersch learn more at floridaestateplanning.com