Home-sale tax break is a boon
for most owners -- Page 2
There even are situations
where owners of multiple properties might be able to double up on the tax-free
"There might be instances where you sell your primary
residence and then establish your vacation home as your primary home for a couple
of years and then sell that home," says Trinz. "Empty nesters who have
a large suburban home could move into a vacation home at the beach and then as
they get older move to a residential facility so they can sell both the homes
and not have any taxable gains."
Be careful, however, if you move into a rental property
you acquired through a like-kind
exchange. The American Jobs Creation Act that was signed into
law on Oct. 22 establishes a tougher test in these cases. If the
property you convert to your principal residence is one that you
earlier obtained via a property swap, in order to take advantage
of the home-sale exclusion you must have acquired the property at
least five years earlier.
Michael E. Kitces, director of
financial planning for the Pinnacle Advisory Group in Columbia, Md., gives this
example: A property is acquired by like-kind exchange in 1999, converted to personal
use as a residence in 2002 and then sold in late 2004. Since the like-kind property
was owned for five years, it meets the new tax code ownership-length provision.
And having met the new five-year acquisition rule for a swapped property, Kitces
says, the owner qualifies for the capital-gains exclusion since he lived in the
property for two years after its conversion. If, however, the property had been
exchanged in 2001, even if the seller had made it his principal residence shortly
after the date of the swap and thereby met the two-year use rule, he still would
be not be able to exclude any profits on the sale.
case, though, the pesky reporting requirement remains history. When your gain
doesn't exceed the limit, you don't have to file anything with the IRS.
rules for married couples
While a husband and wife get double
the exclusion of single home sellers, couples also have some additional considerations
when it comes to determining whether their sale is tax-free.
spouse can meet the ownership test. For example, the IRS says it's OK if you owned
the home for the last two years, but you just added your new husband to the title
when you got married six months ago. Since you owned the residence for the requisite
time, as joint filers you have no problem meeting the ownership test even though
your husband wasn't an official owner for that long.
both husband and wife must pass the use test; that is, each must live in the residence
for two years. But the shared use doesn't have to be while you file jointly. If
you and your now-husband shared the home for 1½ years before tying the
knot and then six months as newlyweds, the IRS will allow you to claim the exemption.
But if he didn't move in until the wedding day, you're out of tax-exclusion luck.
while you're learning about your new spouse, make sure you find out all about
his or her previous home-sale history. "The two-year eligibility rule applies
to both spouses, so full home disclosure is another financial area you need to
consider when getting married," says Trinz. "You need to find out what
Under this couple requirement, if either
spouse sold a home and used the exclusion within two years of the sale of any
jointly-owned property, the couple can't claim the exclusion. That means if your
new husband sold his townhouse a month before the wedding, then you'll have to
wait two years after that property's sale date before you can dispose of your
shared marital residence tax-free.
the correct exclusion amount
OK, you (and your better half
if you're married) met the use and ownership tests, as well as the two-year previous-sale
time limit. Now it's time to do the math to avoid writing a big check to the U.S.
As a seller, you naturally focus on how much you
got for your house. That is an important number, but not the only one you'll need
when it comes to figuring whether you'll owe taxes on the sale.
your gain, or profit, that determines the size or lack of a tax bill. In fact,
you can sell your house for $1 million and still not owe Uncle Sam as long as
the profit portion was not more than $250,000 or $500,000, depending on your filing
status. If you can exclude all the gain, then you owe no taxes.
arrive at your gain amount, you first must establish your basis in the home. For
most people, says Trinz, this is what you paid for the residence and all capital
improvements you've made, such as adding a room or finishing a basement. Also,
if you sold a residence prior to the 1997 law change and rolled the profit into
the home you're now selling, you must account for that rollover amount; your basis
will decrease by the amount of gain you postponed years ago.
you compare that basis amount to what you get from the sale, less your commissions
and other expenses," says Trinz. "When you subtract your cost basis
in the residence, this will give you the amount of gain on the sale."
most instances, sellers will find they made a nice profit, but not one large enough
to trigger a tax bill. Some, however, could find their residences appreciated
so much that the great sales prices they got ended up costing them at tax time.
That's why it's important to accurately track anything
that could affect your home basis.
"In 1997 when
this law first changed, there was a lot of talk about how you no longer have to
keep records of home basis improvements, but the way the home prices have escalated
you're probably safer in keeping those records," says Luscombe. "The
improvements increase your basis, so a smaller portion of the selling price would
be viewed as gain. Any overage is taxed at the [applicable long-term] capital
gains rate of 15 percent or 5 percent.
"For those people,
the old rule might have been better, but the new rule sort of rewards more frequent
changes of homeownership."
exclusion still a good deal
Even if you don't meet all the
home-sale exclusion tests, your tax break might not be totally lost.
an owner sells his house because of special
conditions, such as a change in health, employment or unforeseen circumstances,
he's eligible for a prorated tax-free gain.
In such a case,
the seller first calculates the fractional amount of time that he met the two-year
use test. For example, a single homeowner is transferred to a job in another city
and sells after being in his home for only a year and a half. He would have an
occupancy period of 18/24 (the number months he lived in the home divided by 24,
the number of months in the two-year occupancy requirement) or 0.75. By multiplying
the full $250,000 exclusion amount by 0.75, the seller would be eligible to exclude
a sale gain of up to $187,500.
Members of the military also
home-sale consideration. Because of redeployments, soldiers often find it
hard to meet the residency rule and end up owing taxes when they sell. But a law
change in 2003 now exempts military personnel from the two-year use requirement
(for up to 10 years), letting them qualify for the full exclusion whenever they
must move to fulfill service commitments.
So quit worrying
about taxes when you put your house on the market. Chances are good that Uncle
Sam won't be able to lay any claim to your hefty home-sale profit.