The biggest and most recent federal tax break for homeowners is attracting strong interest throughout the country, but it's also producing a lot of confusion.
Congress' revision of the tax code, permitting homeowners 55 years and older to pocket tax-free up to $100,000 in profit on the sale of their residence, sounds straightforward. But the wording of the law carries enough twists and turns to send many would-be users scurrying for help.
For example, there are definite bonuses tucked away in the new tax rules for people who choose to live together in the same house without getting married.
There are also stiff penalties for anyone marrying a person who already has made use of the $100,000 tax-free provision on a home sale during a previous marriage. (If you marry such an individual -- who may well be under 55 years of age himself or herself -- you lose your own right to qualify for the tax break.)
The rules also subtly discourage long-term rentals of one's home, and extended residence at a second home or vacation property you may own. They also encourage homeowners approaching the age of 50 to begin mapping out their plans for the balance of their lives with capital gains taxes prominently in mind.
The law allows a one-time-only tax-free exclusion of up to $100,000 of the net profits on your primary home, provided you've lived in it for three of the past five years, and provided that either you or your spouse is 55 on the date of sale. (If you're married and file your tax returns separately, you can qualify for up to $50,000 each tax-free.)
The exclusion means that if the resale value of your home has skyrocketed because of inflation over the past 10 or 20 years, you'll be able to keep all of the first $100,000 of that inflated gain for yourself, rather than handing over a big chunk of it to the federal government. Any net profits beyond $100,000 will be subject to capital gains taxation -- at a fraction of your regular income tax rate -- or can be deferred from taxation through reinvestment in another principal residence.
The combination of the age and one-time-only factors in the law produces the first set of potential pitfalls for users of the $100,000 tax break.
The rules allow a husband-and-wife household only one use in their lifetimes. That means that if a 56-year-old husband dies the year after he and his 46-year-old wife make use of the tax break, any man who marries the widow won't be able to claim a $100,000 break for himself as long as they stay married.
The same would hold true if the wife died and the husband remarried, or if the couple divorced after taking the homeowners' one-time-only exclusion.
The divorced or widowed spouse is "tainted" forever, having made use of the $100,000 exclusion. The only way that taint can be removed is through a cumbersome process of revocation that may or may not improve the actual gain to the taxpayer.
Says real estate tax expert Gerald J. Robinson, a New York attorney: "I can foresee numerous situations where my advice to clients would have to be, 'Don't remarry -- just live together in sin. You'll save a bundle in taxes.'"
In the case of two divorced homeowners who could each qualify for large tax-free exclusions, Robinson's advice might be to sell both houses prior to remarriage. (The total tax-free gain there could hit $200,000.) In the case of a widowed or divorced individual who has already used the exclusion, the advice to a prospective spouse might be, "Sell your home now, take the $100,000 exclusion," and then get married.
Another wrinkle in the new law comes in length of residency. To qualify for the $100,000 exclsuion, you must be able to document your ownership and personal residential use of a home for no less than 36 months out of the 60 months immediately preceding sale.
That means that if you've been renting out your large family home and living in a condominium for the past few years, you may have difficulty claiming the exclusion with the IRS.
The time test does not require 36 consecutive months of residence, however. If you rented out your home for a year, 18 months or even two years, for instance, but could piece together 1,095 days of document personal residence in the house (36 months) during a five-year period, you could qualify.
The Internal Revenue Service will permit "seasonal" vacation absences of about two months to count as personal residence, even if you rented out your home while you were away. But if you go away for longer periods, and rent out the house, the days you're gone may not qualify as part of the mandatory 36 months minimum.