Selling your home and moving into another one is seldom an easy decision.
But recent tax law changes may make your decision a little more profitable.
As part of the Taxpayer Relief Act of 1997, Congress included a provision
that will eliminate (not defer… but eliminate) the federal income tax
liability on the gain on the sale of a principal residence for most people.
In the next few weeks we'll look at this provision in detail and discuss
the planning opportunities available to you that may allow you to slash your
income taxes.
The Basics
Under the new law, generally effective for property sales after May 6, 1997,
up to $250,000 of the gain from the sale of a single person's principal residence
is tax-free. That's right -- tax-free. And, for certain married couples filing
a joint tax return, the amount of tax-free gain doubles to $500,000. TAX
FREE!
This new law replaces the old personal residence sale rules. No longer do
you have to "roll over" or "buy up" in order to defer your gain to a later
tax year. You also no longer have to concern yourself with the "over age
55, once in a lifetime" rules regarding the exclusion of $125,000 of your
gain. All of the old rules are effectively out the window (with some minor
exceptions that we'll discuss in detail next week).
The new rules that allow you to take your home sale profits tax-free is now
available to you regardless of your age. It is available to you regardless
of how many homes that you may sell in the future… or have sold the
past. It is available to you even if you previously took a "once in a lifetime"
exclusion. As long as you meet the qualifications, this exclusion is available
for you. Right now.
Example: Sam, age 31, sold his personal residence in June 1997 for
$130,000. Sam originally bought this residence in 1994 for $85,000. Sam's
gain on the sale of his principal residence in the amount of $45,000 is excluded
from tax, and Sam can use these funds however he sees fit. He doesn't have
to buy another home and he doesn't have to be over age 55.
Example: But Sam does decide to purchase another home, and closes
escrow on the new home in August 1997. His purchase price was $110,000. In
October 1999, Sam sells this new home for $160,000. The $50,000 gain on the
sale of this home is also excluded from tax. No tax to be paid whatsoever.
In effect, over a matter of just a few years, Sam has managed to take $95,000
in home sale profits tax free.
And, remember, the new exclusion rules will apply even if you previously
qualified for and took your "once in a lifetime" tax exclusion on a prior
home sale.
Example: Jack and Jill, both age 67, sold their home for $265,000
in January 1998. They originally purchased this home in 1991 for $185,000
using the proceeds from a previous sale that took place in 1990. On the 1990
sale, they took the "once in a lifetime" exclusion since they were over age
55 and met all of the other qualifications. Jack and Jill are still able
to exclude the $80,000 gain on the sale of their current residence. The fact
that Jack and Jill used the "once in a lifetime" exclusion in the past does
not prohibit them from using the new tax laws to exclude their gain on the
most recent sale.
Remember also that the new exclusion rules will apply even if you recently
"rolled over" the proceeds from a prior residence into your current residence.
The law allows you to "tack on" your holding period from a prior residence
to your current residence and allows you to meet the "owned and used" rules
(that we'll discuss a little later).
Example: Frank, age 40, bought his first home in 1990 for $75,000.
In March 1997 Frank sold that home for $110,000 and "rolled" his $35,000
gain over to a new home that he purchased in April 1997 for $115,000. In
September Frank sold his second home for $130,000. Frank can exclude his
total gain of $50,000 attributable to both homes under the new law, even
though he only lived in the second home for less than two years. Under the
law, Frank can tack on the time he lived in his first home to the time that
he lived in his second home in order to qualify for the "owned and used"
rules.
Finally, remember that any gain in excess of the exclusion amount WILL be
subject to taxation, and there is nothing you can do to get rid of that taxation.
You cannot "roll over" any gain into a new residence, because those prior
"rollover" rules are no longer applicable.
Example: Janet bought her home in 1961 for $25,000. Over the past
36 years, Janet paid $45,000 for improvements to the property (new laundry
room, new roof, updated kitchen, etc.). Janet sold her home in November 1997
for $365,000. Janet can exclude $250,000 of her total gain of $295,000…
BUT she must pay tax on the $45,000 gain in excess of the exclusion amount.
And there is nothing that she can do to otherwise defer or exclude that portion
of the gain. While the gain will be subject to the new, generous capital
gain rules, Janet must still "belly up to the bar" and fork some tax dollars
over to Uncle Sammy.
Restrictions
Like virtually all other tax laws, there are some restrictions. This exclusion
has a detailed set of rules that must be followed in order to qualify for
the exclusion. Besides the $250,000/$500,000 dollar limitation noted above,
the seller must have owned and used the home as his or her principal residence
for at least two years out of the five years before the sale. And while the
two years don't have to be consecutive, in most cases you can only take advantage
of this gain exclusion provision once during a two-year period.
Next week we'll discuss these restrictions in greater detail. But if you
want to read ahead, feel free to take a look at IRS Form 2119 and the associated
instructions and/or IRS Publication 17 at the IRS website
(http://www.irs.ustreas.gov).
- 02/12/98
