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Tax Update On Home SalesHome ownership has been encouraged by our government for nearly a century. Deductions for real property taxes and mortgage interest were cemented in place virtually since the 16th Amendment authorized the income tax in 1913.For some 50 years, further tax benefits have been added on the sale of property used as a residence of the taxpayer, up until 1997. On sale of a residence, capital gain could be postponed up to a gain of $125,000. In the Tax Reform Act of 1997, the tax benefit on sale of a residence was substantially improved. After May 7, 1997, if you and/or your spouse sell your principal residence, you can exclude up to $250,000 ($500,000 on a joint return) of capital gain if you resided there for at least two of the last five years, whether or not you buy a new home. This is an exclusion from income, not just a deferment. The improvement in tax treatment is substantial. But there are pitfalls and the rules must be carefully observed. For example, a residence sold before 1997 may have resulted in a deferral of the gain and the value of your current residence is reduced by the amount of that gain. If you must sell your residence within two years, you can get a partial exclusion in proportion to your actual period of residency to the two years. For example, if you must sell for health, employment or other unforeseen reasons (divorce, etc.), after one year of residence, you can claim one-half of the full exclusion ($250,000 or $500,000 if joint), not just one-half of the gain. In most cases, even a partial exclusion will eliminate any tax on gain, which is computed on the capital gain (net of commission, closing cost, etc.) and not the sale price. Computing the "2 in 5 year" period can become a trap if your two year period is not within the five years ending on the date of sale. For example, you live in your residence for two years, then move in with your parents and rent your residence out for four years before you sell. Too late! You just lost the tax on as much as $500,000 of capital gain. Congress enacted an exception in the Military Family Tax Relief Act in November, 2003. Recognizing active duty personnel could not control their time, the five year limit is extended for them to ten years, retroactive to 1997. Refund claims filed by November 11, 2004 will be honored without regard to time limits for active duty personnel. But the message is clear. Government not only favors home ownership, but recognizes that values have risen dramatically. It also recognizes people are becoming more and more transient, thus increasing both the number and frequency of home sales. If you have some question in this area of tax and property law, feel free to contact your Peacock Keller lawyer to guide you through this increasingly common experience of selling your residence at a profit. |
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