Q. I am a senior citizen, and I sell my house for $100,000, realizing a profit of $40,000. I roll over the $40,000 for the purchase of a town house, costing $110,000. As I understand the situation, the basis for tax purposes would be $70,000. Eventually, I want to sell the town house and move into a retirement community. For arithmetic's sake, let us assume that I will get $150,000. As I further understand the situation, my total capital gain would be $80,000. Is this $80,000 capital gain excludable because it is below the $125,000 senior-citizen exemption? My concern is that it really comes from two separate transactions -- the sale and purchase of different homes. I know that many of us "older folks" would like to have your guidance.
A. In a nutshell, the $80,000 capital gain is excluded from your income for tax purposes, on the condition, of course, that you meet the test of the once-in-a-lifetime senior-citizen exclusion. As you know, taxpayers who are 55 years or older are permitted to exclude up to $125,000 of the gain (profit) that they make on the sale of their principle residence, if they have owned and used the residence for a total of at least three years during the five-year period ending on the date of the sale of the house. As this column has reported on earlier occasions, married taxpayers filing separate returns are entitled only to a maximum exclusion of $62,500 on each separate return.
Let us explain exactly how this works, because it often causes considerable confusion among home-owning taxpayers.
You purchased your first house for $60,000, and subsequently sold it for $100,000. Assuming for the moment that you made no improvements to the property, and assuming also that there are no selling expenses (such as real estate commissions or points), your profit is $40,000.
If within a two-year period from the date you sold your house, you purchased another property for more than $100,000, you are entitled to roll over this profit into the purchase price of the new house. In your example, because you purchased the new property for $110,000, subtracting the $40,000 profit (i.e., rolling it over) gives you a new tax basis of $70,000.
Incidentally, two important points should be kept in mind in any discussion of the tax laws:
First, it makes no difference whether your old house is sold before you purchased the new one, or vice versa. So long as no more than two years have elapsed between the sale and purchase, you are entitled to the rollover.
Second, even if you do not put one penny of your profit into the new house, the tax laws still permit the rollover. Thus, if you borrowed $100,000 on the purchase of your new $110,000 property, you are still entitled to roll over your previous $40,000.
Now you want to sell your town house and move into a retirement community. You have indicated that you expect to sell that property for $150,000. Assuming that you meet the test of the once-in-a-lifetime exclusion, your total capital gain for tax purposes is $80,000 ($150,000 minus $70,000).
This $80,000 is eligible for the once-in-a-lifetime exemption, again providing that all of the tests are met.
It makes absolutely no difference whether you have bought and sold one house in your lifetime or 100 houses. The Congress of the United States created this great American housing dream, giving homeowners the rollover benefits until they reach age 55, and then the current once-in-a-lifetime $125,000 exemption.
It is not really complicated. And, even if the president's new tax proposal becomes law, these benefits probably will not be changed.