Chasing away old capital gains issues

Dear Steve,
I am married and selling a home, and my capital gain will be around $800,000. If I buy a home for $300,000 and put the remaining $500,000 in the bank and live off the interest, is that $500,000 subject to a capital gains tax? -- Chris (Awash in) Cash

As for the capital gains issue, I think you are confusing elements of pre-1997 tax law with revisions. So, in the spirit of the New Year, let's "out" with the old.

Under the former law, you could defer some capital gains taxes by buying a replacement residence with profit from the sale. However, when the rule changed after May 6, 1997, that replacement component was eliminated.

But not to worry. When the law was altered, the capital-gains exclusion ceiling was also upped from $125,000 per sale per individual to $250,000, or $500,000 for a married couple filing jointly. That's a proviso that should benefit you and your spouse richly, Chris.

Hence, the two of you are apparently due exemptions on $500,000 of your hearty capital gain, providing you have owned and used the home as your principal residence for a combined period of at least two years prior to its sale.

The law change has probably spurred some real estate turnover since it passed. That factor, combined with low interest rates and relaxed lending standards, have helped keep the residential market buoyant during the economic turbulence of the past two to three years.

In short, Chris, you'll probably find a buyer for your house, although high-end homes aren't moving quite as quickly as low-to-mid-range units these days.

But here's the truly bad news, if there is such a thing in a mega-windfall such as yours. It looks like you're going to take a tax hit on the remaining $300,000 cleared from the sale. Naturally, you'll want to check with a financial/tax adviser to explore options on a transaction of this size. You also should carefully review what improvements you may have made to the home, and how that might reduce your tax liability.

For future reference, note that if your home had been an investment property, you could defer taxes from its sale by buying a replacement investment property within 180 days, in a 1031 Exchange. This may have been a source of initial confusion.

As far as "living off the interest" on the $500,000 that remains after your planned home purchase, I hope you don't plan to live too large. Interest rates on certificates of deposit and other traditional savings vehicles, while slowly rising, are still pretty slim. Again, a chat with a money pro could steer you in a more lucrative direction.

Good luck.