From: jdavidso@teknowledge.com (Jim Davidson)
Newsgroups: misc.invest
Subject: Re: Buying down....
Date: 25 Aug 92 17:56:59 GMT
Organization: Cimflex Teknowledge Corporation, Knowledge Systems Division
In-reply-to: mcaldon@igc.apc.org's message of 22 Aug 92 05:59:00 GMT

In article <1426500247@igc.apc.org> mcaldon@igc.apc.org (McAldon International Inc.) writes:

> |Fix-up expenses are *never* deductible.  Under certain circumstances, they
> |enable you to *defer* taxes (not deduct -- note the difference).  I.e., you
> |can reduce the amount of the gain that is taxable *in the current year*.  The
> |tax *will* ultimately be paid.
> |[...]
> |-Jim
> 
> My language was faulty but the gist was correct.  The fix-ups are deductible 
> FROM THE SELLING PRICE.  So what's the difference?  You pay tax on the profit
> -- selling price minus cost basis.  Reference: JK Lasser,1992.  DMcKenzie

Actually, fixups are deductible from the "adjusted sale price".  This is one
of several quantities that are used to determine tax treatment.  

Let's go into this in a little more detail, and clarify some things.  The
following information is taken from the latest Lasser guide, cited by the
previous poster.  

Here are some simplified definitions:
	
- the "basis" is the cost of a house, plus misc. fees, plus improvements;
- the "amount realized" is the selling prices, minus commissions;
- the "adjusted sales price" is amount realized, minus fixup expenses.

I'll make this more concrete, using some example numbers borrowed from Lasser:

The person owns a house, bought for $124,500.  Spends $800 fixing it up,
then sells it for $175,000, paying commission & selling expenses of $11,500.

Sale price:		$175,000
Commissions & exp	($11,500)
			--------
Amount realized		$163,500
Cost basis of house	$124,500
			--------
Actual gain		 $39,000

The "actual gain" is the amount that the homeowner will (ultimately) pay tax
on.  Note that fixup expenses *don't* figure into this at all.

"Improvements", had there been any, would have been added into the cost basis,
thereby reducing the actual gain.  This is the point to note: improvements
reduce your gain, and thereby reduce the taxes payable.  Fixups do not.

OK so far?

Now, although you can't avoid paying taxes on the actual gain, you can *defer*
it.  The most common way is by buying another house.  To determine how much of
the gain you can defer, compare the "adjusted sale price" to the cost of the
new house.

Suppose our example homeowner buys a new house for $161,000:

Amount realized		$163,500	(from above)
Fixup expanses		($   800)	
			--------
Adjusted sale price	$162,700
Cost of new house      ($161,000)	
			--------
Taxable gain		$  1,700

This "taxable gain" is the amount that is taxable *this year*.  The "fixup
expenses" have helped to reduce the taxes payable in the current year.

As I mentioned above, the remaining gain ($39,000 - $1,700) hasn't gone away;
it's just been deferred.  It gets subtracted from the cost basis of the new
house, making it: $161,000 - $37,300 = $123,700.  When the homeowner eventually
cashes out, taxes will be due on that gain.  (Actually, if the homeowner
shows a loss somewhere downstream, he may avoid paying on the gain, but that's
a different issue.)

To summarize: Improvements reduce your "actual gain", and thereby reduce
your taxes; fixups reduce your "taxable gain", and thereby enable you to
*defer* taxes.

Note that, if you're "moving up" (i.e., buying a more expensive house), fixups
are a no-op, since you defer *all* the gain anyway.

-Jim