TAXES  -  HOME SALES

Current Law Benefits Home Sellers

Homeowners, particularly those whose homes have appreciated in value a great deal, can reap tremendous benefits from the tax rules for homeowners.

The new law applies to all homeowners, regardless of age. The new law allows an exclusion of up to $500,000 for couples filing jointly and up to $250,000 for single taxpayers on the gain from the sale of their principal residence. Previously, the exclusion was $125,000 and it was available only once for singles or marrieds who were age 55 or over.
 
 

Who Benefits Most?

 Most taxpayers stand to benefit from this change.
 

People who want to downsize their homes or go from owning to renting - which often occurs at retirement - stand to be able to pocket a lot more money than they had been able to in the past when the maximum exclusion was $125,000.

People who enjoy fixing up houses, living in them, and then selling them to fix up another house could also stand to benefit handsomely from these new rules.

Finally, people who own more than one highly appreciated home may be able to move from home to home, establish principal residency for two years in a particular home, sell it at a substantial, tax-free profit, and then move on to another of their homes.
 
 

Are You Eligible?

A seller of any age who has owned and used a home as a principal residence for at least two of the five years before the sale can take advantage of the new capital gains exclusion.

In general, the exclusion can only be used once every two years. More specifically, the exclusion does not apply to a home sale if, within the two-year period ending on the sale date, you sold another home and applied the exclusion.

The definition of a principal residence includes a conventional single-family home, house trailer, mobile home, houseboat, condominium, cooperative apartment, duplex or row house. It may even include a boat if it contains facilities for cooking, sleeping, and sanitation.

A relief provision may apply if a principal residence is sold but fails to meet the exclusion rules. If the reason why you fail to meet the guidelines for the exclusion is that you were forced to sell your home because of a job relocation or change, health, or to some unforeseen circumstances (to the extent provided by the income tax regulations) you, as the homeowner, may be entitled to a partial exclusion.
 
 

EXAMPLE: Mary Marston was just transferred by her employer to another state. She had occupied her current home for only 14 months, but, thanks to a hot real estate market, she sold it for a handsome gain. How much of the gain can Mary, who is single, exclude? Up to $145,833 (14 months divided by 24 months, multiplied by $250,000).
 
 

Have You Depreciated Part of Your Home?Special rules apply where a portion of the residence has been depreciated for tax purposes. This could limit the amount of excludable capital gain. For example, if part of the home was used for business purposes or as a rental property, then you would owe capital gains tax to the extent of any depreciation that was allowable with respect to such business or rental use after May 6, 1997.
 
 

Special Rules

To make the new exclusion available to more taxpayers, special rules cover common situations that might not otherwise meet the two-years-out-of-five ownership and use requirements.  Specifically:

Any sale before August 5, 1999 of a principal residence held by the taxpayer on August 5, 1997 qualifies for the exclusion subject to proration rules.

Taxpayers who have recently rolled-over their gain to a replacement residence may count the time they owned and used their former residence toward meeting the holding requirements for their current residence.

Tenant-stockholders in a cooperative housing corporation can qualify to exclude gain from the sale of that that stock.

Gain from the sale of a home incurred by spouses, surviving spouses and separated or divorced persons can often be excluded even though they do not personally meet the ownership and use requirement.
 
 
 
 

Record Keeping is Still Important

With such a generous exclusion from capital gains, many taxpayers probably think that they no longer have to maintain records of home improvements. But that would be unwise for a couple of reasons. First, it's impossible to predict how much you'll sell your house for. If you're fortunate enough to make a killing on it, you'll be glad you kept home improvement records because you'll be able to increase the tax cost basis of your home and therefore eliminate or reduce any capital gains tax bite. But even if a whopping gain isn't in the cards, you'll need records of your home's purchase price and improvement to compute any casualty loss deduction if some calamity befalls your home. Also, those records could be crucial in getting a fair insurance settlement.

Common Sense Rather Than Tax Avoidance Can Guide Future Home Sale and Purchase Decisions

Finally, since most homeowners no longer have to reinvest home sale proceeds to avoid paying tax, you can base your decision about the size and cost of your replacement home on factors other than tax consequences. This could be especially beneficial to taxpayers who relocate from an area where home values are relatively high to an area where the values are lower, or for those who simply want to downsize.