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Act fast: Capital gains could jump in 2013

"A house divided against itself cannot stand" is how Abraham Lincoln put it. While we're not in Civil War territory today, we're definitely in a place of political impasse.

Homeowners take note: Our government is likely too divided to stop the Bush tax cuts from expiring at the end of 2012, no matter who the next President is. You can still sell your house under the current tax code, but you must hurry.

If you're like some of my clients, there's a lot at stake. The Smiths bought their classic bungalow on a shady street in Palo Alto in 1971 for $151,000. That same house is now worth a tidy $2.5 million. Yes, it's a great problem to have, but it's also better to pay the current 15 percent long-term capital-gains tax, than next year's expiration-driven rate of 20 percent. Also, add the Medicare tax of 3.8 percent on gains, recently upheld as part of the new federal health-care program, and you're looking at a nearly 9 percent rise in taxes. If, after adding the cost of capital improvements, the Smiths have a basis of $400,000 and net $2,000,000 after costs of sale, they have a long-term capital gain of $1,600,000. Even with the $500,000 tax-free gain exclusion given a married couple on a primary residence, that's the difference between $165,000 in taxes this year versus $261,800 the next. Keep in mind, too, that the pre-Bush capital-gains rates are not a ceiling. A nation that keeps talking about balancing its books is a nation likely to raise taxes, before too terribly long.

The lesson here? If you're thinking about selling, ask yourself if you're confident your house will be worth 15 percent more next year -- because that's the magnitude of gain you'll need to cover a bigger tax hit. If you decide to take the money and run, do it now and don't wait to the last minute. That's what everybody else is going to do. And yes, in my world, it's almost the last minute. Not only is 2013 coming fast, but the closer it gets the more likely it is to cause a stampede of sellers who, together, drive prices down.

Now for those of you who have been adults for a while, I think it's worth noting that you can no longer skip capital gains by using the proceeds to buy a more expensive house. That little dance move was removed from the tax code quite a while ago and replaced with the $250,000 exclusion of tax on gain on the sale of a primary residence ($500,000 for a married couple). If you did partake in the old tax law, don't forget that you have carried that gain with you.

At whatever rate you end up paying, the measurement for capital gains is what you sell your property for minus the purchase price and the cost of capital improvements. Maintenance and repair, like painting your house, is not a capital improvement and so not added to your basis. However, in the last 90 days before you sell your house, more fine print starts to work in your favor. Any decorating or repair expense -- such as painting, landscaping, wallpapering or fixing the chimney -- is deemed a deductible selling cost, as are advertising fees, administrative costs, inspection fees, legal costs and your real estate broker's commission.

Michael Dreyfus founded boutique brokerage Dreyfus Properties, with offices in Palo Alto and Menlo Park, in 2000. He can be reached at mdreyfus@dreyfusproperties.com.

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