Your Home Is A Giant Municipal Bond With A Roof
Essentially, Your Home Is ...
A Giant Municipal Bond
With A Roof
Capital Gains Tax & The Sale Of Your Home
For the most part, federal tax law permits you to sell a primary residence every two years and pocket any profit that you make TAX FREE.
According to the latest more lenient laws on capital gains tax, you're not likely to pay taxes on the profit you make when you sell your house. But there are rules you have to live by.
Before Congress passed the Taxpayer Relief Act of 1997, you basically had two choices when you realized a gain on the sale of your primary residence: 1) pay capital gains taxes on the gain or 2) buy a house of equal or greater value within two years.
Back then, there was one modest accommodation for older homeonwers: If you were over 55 years of age, you could you exclude a certain amount of the gain from taxation ONCE in your lifetime.
NO MORE! Now virtually all sellers (except those at the highest end of the market) can keep any profits they make on the sale of a house with negligible tax consequences - making homeownership a potentially lucrative long-term savings vehicle.
Understanding Captial Gain
For home sellers, capital gain is the difference between what you paid for a house and what you sell it for, minus the cost of any capital improvements. Capital improvements are home improvements that change the structure or livability of your home, such as an added room or remodeled kitchen. Today's tax rules allow the following:
- Married couples or co-owners who file taxes jointly may keep $500,000 in profits tax-free on the sale of a home they have owned and lived in for two of the past five years. Anything above that amount is taxed at the capital gains rate (currently 15 percent)
- Single homeowners may keep $250,000 in profits tax-free on the sale of a home they have owned and lived in for two of the past five years. Anything above that amount is taxed at the capital gains rate (15 percent).
- Rental property owners may defer some capital gains tax if they purchase another rental property and qualify for a §1031 Tax Deferred Exchange , but not if they buy a personal residence.
Time Limit Requirement
If you own your house for less than two years before you sell, you can still qualify for a prorated exemption. For example, if you're single, sell a house you've lived in for one year, and make a profit of $150,000 on the sale, you would apply the residence-period fraction - one year is one-half of the two-year time-limit requirement¿to the $250,000 maximum, for a total of $125,000. This means you would pocket a tax-free $125,000, and pay tax on the remaining $25,000.
You can even get a partial exclusion based on the time of use and ownership. But you only get the partial exclusion if the sale is a result of:
- A change in place of employment, or
- Health reasons, or
- Unforeseen circumstances.
The partial exclusion is based on the maximum exclusion, not on the basis of your actual realized profit. So, say you bought a home for $250,000 and sold it, because of a job change, for a $25,000 profit after only one year.
Because the sale was covered by a change in employment, you get a partial exclusion. It was your principal residence for one year out of two, so 50% of the maximum exclusion, up to $125,000 in total gain, is excluded. Since that's more than the $25,000 gain you actually realized, no tax is due on the sale. That's because you exclude half the maximum allowed, not the gain itself. It's a major tax break. Not many properties are going to appreciate more than $125,000 - $250,000 in one year.
The key is to qualify for the partial exclusion if possible. "Change in employment" covers anyone who lives in the household. The person doesn't even have to be an owner of the property. The "change in employment" must be the primary reason for the move. There's a "safe harbor" that assumes that it was the primary reason if your new job is at least 50 miles farther from the residence sold than where you used to work.
But if you don't meet the "safe harbor," all is not lost. You'll just have to prove (if you're audited) that it was the primary reason for the move based on the facts and circumstances of your case.
Health reasons include advanced-age-related infirmities, the need to move to care for a family member, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury.
Unforeseen circumstances are where the IRS really became consumer-friendly. Safe harbors here include divorce, death, multiple births from the same pregnancy and even a change in employment or self-employment status that results in your inability to pay the costs and living expenses of your household. So, if your income goes down, or even if your spouse or other co-owner's income goes down, you can qualify for a partial or even a full exclusion.
Even if you don't qualify for one of these "safe harbors," you might still qualify on the basis of your specific facts and circumstances.
To read about additional tax benefits of homeownership:
READ - "The Great American Tax Shelter" - Uncle Sam's Generous Gift To Homeowners
Note: This article is not intended as legal or accounting advice.
Before making any decisions, seek the advice of an attorney and/or accountant.
© Copyright 2007 Bill Boeckelman Publications