For Sale by Owner News and Articles
On August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 ("'97 Act"), the most significant overhaul of federal tax laws since the 1986 Tax Reform Act. Included in the new legislation are a number of favorable tax provisions, including the much heralded cut in the capital gains tax rate.
Home Sale Exclusion
Prior to the new law, any gain on the sale of a principal residence could be "rolled over" tax-free to another principal residence provided the sales proceeds were reinvested in a new home of equal or greater value within two years before or after the sale. In addition, for home sellers age 55 or older at the time of sale, a one-time election to exclude up to $125,000 of gains could have been made if the seller had owned and used the property as a principal residence for at least three of the five years immediately preceding the sale.
The new law repeals the above tax-free rollover and one-time exclusion provisions, replacing them with a new home sale exclusion, which is generally available only once every two years. Effective for home sales after May 6, 1997, up to $250,000 of gains can be excluded from gross income, provided you owned and lived in the home for at least two of the previous five years. Married couples filing jointly can exclude up to $500,000 of gain if both spouses meet the two-year residency requirements, at least one spouse meets the two-year ownership requirement, and neither spouse has excluded gains on a home under the new rules within the preceding two years. However, if you fail to meet the ownership and use requirements by reason of a change in place of employment, health, or other unforeseen circumstances, you can still exclude the fraction of the $250,000 ($500,000 if married filing a joint return) equal to the fraction of two years that these requirements are met. As an example, if you have lived in your home for 18 months with your spouse and relocate for job reasons, you can exclude up to $375,000 (3/4 x $500,000).
The home sale exclusion should allow most taxpayers to base future housing decisions on personal and nontax financial considerations following the sale of a current residence. For example, empty-nesters looking to "downsize" or individuals planning a postretirement move to a "lower-cost" area can trade down to a less expensive residence rather than feeling pressured to reinvest all of their sales proceeds in a new home of equal or greater value simply to reduce taxes. A retiree will then be able to put home equity to a more productive use (e.g., by reinvesting a portion of the sales proceeds in higher-growth or income-producing assets).
Not everyone wins under the new rules. If the built-in gain on your home exceeds the $250,000/$500,000 cap, you will have to pay tax on a sale, even if you reinvest all the proceeds. Previously, if you only traded up, you could keep deferring the gain until your death, when it would vanish due to the stepped-up basis your heirs would receive.
The new exclusion should ease the record keeping requirements for most taxpayers by eliminating the need to document minor home improvements (records documenting the original acquisition cost of the residence should still be maintained). However, record keeping may become more important for homeowners who see a potential to realize gains in excess of the exclusion allowances, since, as just noted, they will no longer be able to indefinitely defer gains.
The new law does not change the tax treatment of losses on the sale of a personal residence - i.e., they are still considered nondeductible personal losses. In addition, taxpayers that use their principal residence in part as a rental property or business will be required to recognize gain currently on the sale of the property to the extent of depreciation deductions allocable to periods after May 6, 1997. For gains taken in account after July 28, 1997, the 25 percent maximum rate applicable to depreciable real estate is available only if the residence was held for more than 18 months.
Since post-May 6, 1997, depreciation deductions on a current residence used partly for rental and/or business purposes will result in a taxable gain upon sale (to the extent of such depreciation deductions), consider a "like-kind" exchange of your current home for a new residence if you intend to use the new property partly for rental and/or business purposes. Provided the requirements for like-kind exchange treatment are met, you should be able to postpone the gain attributable to the depreciation deductions (your tax basis in the new property would be decreased by the amount of any gain deferral).
Because the materials covered in this article are complicated, this article should not be regarded as offering a complete explanation and should not be used for making decisions. Any suggestion should be reviewed with your personal financial and tax advisor.
© Copyright 1998 by Ernst & Young. All Rights Reserved.