Q: My wife and I are in our mid-60s and will retire shortly. We have a lot of equity in our house. When we sell it, we will have to show a substantial profit. We have heard about the once-in-a-lifetime exclusion of the first $100,000 of profit. Do not know whether this applies to us? Can you explain this exclusion?
A: The Revenue Act of 1978 created a very favorable climate for senior citizens. In effect, it was the culmination of the great. American housing dream which Congress has been refining for these many years.
As you know, when you sell your principal residence, if you purchase another house within 18 months which is equal to or greater than the sale price of your present house, you can defer the gain (profit) on the sale of your house. This is, in effect, a "sell now, pay later" arrangement. The deferral does not avoid the taxes, but merely postpones them.
The theory of the deferral is that when you finally sell your last house, presumably you will be in retirement and your tax rate will be lower.
Prior to the Revenue Act of 1978, if a seller of real estate was 65 years of age, owned the property and used it as a principal residence for at least five years, the first $35,000 of gain was sheltered.
The Revenue Act of 1978 drastically liberalized these rules.
Specifically, the once-in-a-lifetime exclusion applies to all taxpayers, age 55 or older, prior to the sale of the property. To qualify for the exclusion, the seller must have owned the residence and used it as his or her principal residence for at least three years during the five-year period preceding the sale.
Finally, the most significant amendment enacted in 1978 was the dollar amount of the exclusion. Now, the law permits any taxpayer over the age of 55 to exclude the first $100,000 of gain from income tax.
This is not a simple matter. You should probably consult your tax adviser to assist you. For example, if you plan to purchase another house, which is equal to or greater than the value of your present house, it may pay you to defer -- not avoid -- the profit. After all, if the new house you plan to purchase will be your "principal residence," why should you lose the once-in-a-lifetime tax exclusion at this time?
Your tax adviser will also be able to calculate the best approach for reporting the gain on the sale of your old house. For example, if you buy a new residence, which is less expensive than your old house, it is possible to use both the avoidance formula as well as the deferral formula.
You indicated that you are in your mid-60s. If you are 65 years of age or over, you are permitted to take the $100,000 exclusion if you used your house as a principal residence for five out of the last eight years. This applies to all sales through July 25, 1981.