Tax exclusions offer big benefit to home sellers
"The more you earn, the less you keep, And now I lay me down to sleep.
I pray the Lord my soul to take, if the tax collector hasn't got it before I wake."
-- Ogden Nash
Many home sellers made little profit or sold at a loss last year. But homeowners who bought years ago and benefited from the huge gains during the first part of this century might be pleasantly surprised. If you are married and meet the legal requirements described below, you can exclude up to $500,000 of the profit you have made.
If you are not married or file a separate tax return, the exclusion is reduced to $250,000 of the profit. You will not have to pay any tax on that portion of the excluded profit. For many years, two tax concepts helped save sellers from paying a lot of capital gains tax: The "roll-over" rule, which required that sellers buy another home that cost at least as much as the old one, and the "once in a lifetime" exemption for homeowners older than 55. But both were abolished in 1997. What exists is the $500,000/$250,000 capital gains exclusion. There are no restrictions on the number of times this exclusion can be used, but the law contains two important conditions:
You must have owned and used the home as your principal residence for two out of five years before the house is sold. This is known as the "ownership and use" test. If you are married, husband and wife must meet the use test, but only one spouse has to meet the ownership test. If you cannot qualify jointly, but one spouse can meet both tests, he or she can claim the up-to-$250,000 gain exclusion.
In the event of a divorce, the use requirements will include any time that the former spouse owned the property before the transfer to the other spouse.
If your spouse died before the house is sold, your use and ownership includes any time in which your spouse owned and used it. So if you meet the two tests, if you sell the house within two years from the date of death, and you have not remarried at the time of the sale, you can take the full $500,000 exclusion.
The exclusion is generally applicable once every two years. However, if you are unable to meet the two-year ownership and use requirements because of a change in employment, health reasons or unforeseen circumstances (which have been defined by the IRS), then your exclusion is prorated. These prorations are complex and have caused considerable confusion among lawyers, taxpayers and the Internal Revenue Service.
The IRS regulations allow taxpayers to claim a partial exclusion if they sold the home because of a change in the place of employment, health or unforseen circumstances. Let's look at these items separately: