Capital gains
taxes
Computing capital gains on home sale

To 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.

"Then 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."

In 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."

Partial 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.

When 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 of 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 get special 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.

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