Every year tax professionals get asked many of the same questions about certain tax issues. There are several issues that many people believe are hard facts, and that tax preparers get questions about every year. Most of these beliefs are either partially or totally incorrect. As another tax season draws to a close, this is a good time to address several of these tax myths.

Myth # 1: Reinvestment of gain on a sale of a stock or mutual fund.

This is a question that gets asked quite often. “If I sell a stock or mutual fund and reinvest in another stock, do I have to pay tax on the gain”? The IRS rules, in most cases are very specific on the treatment of gains on the sale of stock or mutual fund. The gain is taxable at the time it is recognized. A gain is recognized when the security is sold. In the case of a mutual fund it does not matter if the taxpayer purchases another fund in the same fund family. There is a very limited exception to this rule and it deals with the sale of a publicly traded security and the purchase of specialized small business stock. This exception is very rare. If you feel that you are involved in a qualified sale and purchase consult with you tax professional.

Myth #2: Reinvestment of gain on the sale of property.

This is a slightly different version of the first question. The basic belief is that if someone sells a property they can avoid the tax on the gain by purchasing a new property with the sale proceeds. Part of the confusion in this area stems from 2 areas, the old principal residence sale rules, and like kind exchange rules. At one time if you sold you home at a gain you could postpone the tax by purchasing a more expensive house. The house sale rules were changed in 1997. The current rules allow a taxpayer to exclude from income up to $250,000 ($500,000 for a married couple) gain on a qualified principal residence. This rule never applied to any property that was not the taxpayer’s principal residence.

The other area of confusion is the like kind exchange rules. A taxpayer can postpone the tax on the gain from an asset exchanged in a qualified like kind exchange. The rules for a qualified like kind exchange are rather complex, and we won’t get into the details in this article. The important point is that cash is never like kind property. If a taxpayer sells a piece of property and later purchases another piece, that is not a like kind exchange. The rule in this case, which is the most common occurrence, are the same as the stock sales listed above. The gain is calculated based on the sale price; expense of the sale and the cost basis of the property, if the sale results in a gain it is taxable.

These are two of the common tax myths, concerning the tax on gains from sales that are still very prevalent. In the part 2 we will explore some more common tax myths and attempt to give you the necessary information to separate myth from fact.

Jump to: Common Tax Myths Part 2 - 6/09/06