Last week we discussed the
new rules
regarding the tax exclusion for gains from a home sale and warned you that
there are some restrictions attached to this exclusion. This week we'll look
at those restrictions in greater detail.
The Restrictions
As we noted last week, in order to claim the exclusion for the gain on the
sale of your home you must have used the home as your principal residence
for a period of two years or more in the five-year period ending on the date
of the sale of the home.
The IRS says that you will meet the test if you can show that you owned and
lived in the property as your principal residence, or main home, for either
24 full months or 730 days during the 5-year period ending on the date of
the sale. And while short, temporary absences for vacations and other seasonal
absences will count as periods of use, converting the property into a rental
unit if you move to another primary home may jeopardize your use of the
exclusion.
Example: On July 1, 1993, Barbara bought a condo for $125,000 and
moved into it as her principal residence. Barbara usually spends 3 or 4 months
in Europe each year, enjoying both the beer gardens and castles of Germany.
But, in May 1996, Barbara's health took a turn for the worse, and she decided
to move into an assisted living facility. On December 10, 1997, while still
residing in the assisted living facility, Barbara sold her home for $195,000.
Barbara may exclude the $70,000 gain on the sale of her principal residence
because she met the ownership and use tests.
Barbara's 5-year period is from December 9, 1992 to December 10, 1997 (the
date that she sold the property). She owned the condo from July of 1993 to
December of 1997, which is certainly more than two years. In addition, she
lived in the condo from July of 1993 to May of 1996, which is also over two
years. So since Barbara met BOTH of the ownership and use tests, Barbara
will qualify for the exclusion. And remember to note that Barbara's annual
trips to Europe do not reduce her use of the property as her principal residence.
Temporary absences, such as for vacations, do not reduce the months of use
of the property.
Reduced Exclusion
Well, what happens if you are unable to meet the "own and use" restrictions.
Does that mean that you lose the entire exclusion? Nope. Not at all. If you
can't meet the restrictions, you may still be able to exclude part or all
of your home sale gain if EITHER of the following conditions exist:
1. You owned your residence on August 5, 1997 and sold it after that date
but before August 5, 1999. Your reason for selling the residence is immaterial.
2. You fail to meet the "own and use" qualification and/or the "only once
every two years" qualification because you had to sell the home due to a
change of your place of employment, health, or because of other unforeseen
circumstances.
Example: Tom bought his home in May 1997. In January of 1998 Tom sold
the home and decided to move to Costa Rica and retire. Even though Tom did
not meet the 2-year "own and use" test, he may still be able to exclude part
or all of his gain because exception 1 above was met (he owned the home on
August 5, 1997, and sold it before August 5, 1999).
Example: Jerry bought his home in January 1996. In September 1997
Jerry sold his home because he was relocated to another state by his company.
Even though Jerry didn't meet the "own and use" tests, he will still be able
to exclude part or all of his gain because exception 2 above was met (he
had to sell his home because his employer changed his place of employment).
Computing the Reduced Exclusion
We now know that Tom and Jerry may qualify for a reduced exclusion. Now we
need to know how much of the exclusion is reduced and how much is allowed.
The IRS says that we need to follow a four step process:
1. Determine the number of days that you (a) "used" the home as your principal
residence and the number of days that you (b) "owned" the home as your principal
residence. Use the SMALLER of (a) or (b) as your starting point.
2. Divide the result in number (1) by 730 days (which represents two full
years of use).
3. Multiply the result in (2) by $250,000 (for a single person)
4. The exclusion will be the LESSER of the gain on the sale of the property
or the result in (3).
Example: Looking back at the example above, lets assume that Tom owned
and used his home for 250 days, and that the total gain on the sale of his
property was $30,000. In order to compute the amount of this $30,000 that
he may be able to exclude, Tom would take his number of days owned and used
(which are the same in this example) of 250 days and divided those days by
730 days. Do the math and you arrive at a result of 0.342466. Then multiply
Tom's maximum exclusion of $250,000 by this result and you'll arrive at an
amount of $85,616. Since Tom's total gain on the sale of his property was
only $30,000, Tom will still be able to exclude the entire gain, even though
he did NOT meet the 2-year "own and use" test.
Example: Again, looking back at the second example above, let's assume
that Jerry owned and used his home for 615 days before it was sold, and Jerry
realized a gain of $220,000 on the sale of the property. Jerry would divide
the number of days used (615) by the two year amount (730) to arrive at a
result of 0.842466. Jerry will then multiply $250,000 by this result to arrive
at a maximum exclusion of $210,617. So, while Jerry realized a gain of $220,000
on his home sale, he can only exclude $210,617 of that amount. This means
that Jerry will be required to pay taxes on the remaining $9,383 gain.
Did you find it a little odd that all of the examples had to do with single
people? As well you should since the rules are a bit different for married
folks. We'll look at those differences in the final installment of the home
sale rules next week.
- 02/19/98
