Capital gains tax break a boon for owners
the best tax break available to Jane and John Q. Public? If they're homeowners,
it's selling their house.
Homeowners already know
the many tax
breaks that Uncle Sam offers, most notably mortgage interest and property
tax deductions. Well, he also has good tax news for home sellers: Most of them
won't owe the Internal Revenue Service a single dime.
you sell your primary residence, you can make up to $250,000 in profit if you're
a single owner, twice that if you're married, and not owe any capital gains taxes.
"Most people are not going
to have a tax obligation unless their gain is huge," says Bob Trinz, a senior
tax analyst at RIA, which provides tax information and software to tax professionals.
sellers are surprised by this break, especially if they've been in their homes
for a while. That's because before May 7, 1997, the only way you could avoid paying
taxes on your home-sale profit was to use the money to buy another, more-expensive
house within two years. Sellers age 55 or older had one other option. They could
take a once-in-a-lifetime tax exemption of up to $125,000 in profits. And in all
instances, there was tax paperwork (Form 2119) to fill out to show that you followed
But when the Taxpayer
Relief Act of 1997 became law, the home-sale tax burden eased for millions of
residential taxpayers. The rollover or once-in-a-lifetime options were replaced
with the current per-sale exclusion amounts.
is some logic to this law change because most people under the prior rules didn't
recognize a taxable gain because they rolled it over into another residence,"
says Trinz. "The change essentially makes it easier to dispose of your residence."
some requirements to meet
If you used pre-1997
rules for residential sales, don't worry. That doesn't disqualify you from claiming
the exclusion on any residential sales now. The law change applies to all sales
since it took effect.
of the new rules: You don't have to buy another home with your sale proceeds.
You can use the money to travel to Europe in style, buy an RV and drive across
the country or get all those designer shoes you never could afford before.
better, there's no limit on the number of times you can use the home-sale exemption.
In most cases, you can make tax-free profits of $250,000 (or $500,000 depending
on your filing status) every time you sell a home.
but we are talking taxes here. You did notice that phrase "in most cases,"
didn't you? Before you put a "For Sale" sign in the yard, you need to
make sure your house-sale situation is one of those "most cases."
the property you're selling must be your principal residence. That means you live
in it. This tax break doesn't apply to a house or other property that you have
solely for investment purposes. In those cases, the usual capital
gains rules apply.
You can, however,
turn a rental house into your primary residence, making the sale of it eligible
for the exclusion. This is accomplished when you meet the IRS use and ownership
tests: You own and live in the home for two out of the five years before the sale.
And your actual habitation of the
home doesn't have to be sequential, notes Mark Luscombe, lawyer, accountant and
principal tax analyst at CCH Inc., a Riverwoods, Ill.-based provider of tax law
information and software. The IRS lets you aggregate your time living in the house
to meet the two-year residency requirement.
if you owned and used the home as your main home for periods totaling at least
two years within five years ending on the date of these sale, you're eligible
for the exclusion," says RIA's Trinz. "You look back at the last five
years. Ownership and use may be at two different times. This would apply if you
owned a home for five years, but didn't use it as your primary residence for that
full period. For the first three years, you rented it and then moved into it as
your main home for the final two before you sold it."
you don't even have to live in the house at the date of sale. The flexibility
of the use test means you could live in your house for a year, rent it for two,
move back in for another year and rent it again the year before you sell. Since
during those five years you owned and lived in the property for two years, you
meet the use and ownership tests.
while technically there's no limit on the number of homes you can sell and reap
tax-free gain, each sale must be at least two years apart. That still leaves you
room to make some money on several properties. You can sell your residence this
year, pocket any gain within the tax limits and buy a new residence. Two years
later, you can do the same thing, again and again every two years.