My wife and I (both over 55) are going to move back west next year into a home we are buying there. We plan to rent our Virginia house for the time being rather than sell (we want to make sure the new place fits our needs). It is to our tax advantage to consider our present house, which we have owned for more than 30 years, as our principal residence so we can obtain the once-in-a-lifetime $125,000 tax benefit when the house is sold. Given our plans, does that mean we have to sell our house here within two years after we leave so that it is still our principal residence for three years prior to sale?
One of the few tax benefits that Congress did not take away when it enacted the 1986 Tax Reform Act is the senior citizen once-in-a-lifetime exemption. And, indeed, because the capital gains tax has been eliminated, the once-in-a-lifetime exemption may mean much more to many taxpayers now than in the past.
The once-in-a-lifetime exemption permits taxpayers to exclude up to $125,000 of profit in their personal residence if certain conditions are met. These conditions include:
The taxpayer must be at least 55 years old before the date of sale.
The exclusion applies only to the sale of the principal residence, although this includes condominiums and cooperative apartments as well.
The taxpayer must have owned and used the property as his or her principal residence for a total of at least three years during the five-year period ending on the date of the sale.
For married taxpayers filing separate returns, the maximum exclusion is $62,500 on each return. If one spouse meets all three requirements for the exclusion, both spouses are treated as meeting the requirement.
This benefit is the ultimate manifestation of the Great American Dream that Congress has been fostering for many years. As you buy and sell real estate before you turn the age of 55, you are entitled to a rollover. This means that if you buy a house within two years from the date you sell your old house, and if the cost of the new house is equal to or greater than the selling price of the old house, the profit that you made on the sale of the old house is "rolled over" into the new property.
For example, let us assume that you paid $50,000 for your old house and sold it for $100,000. For sake of discussion, we will ignore any costs, such as fixing-up expenses and real estate commissions. If you buy a new house, for $100,000, the $50,000 profit is "rolled over" into the new property. This means that although you paid $100,000 for the new house, your basis for tax purposes is $50,000.
Thus, if you were ultimately to sell your house for $200,000, even though you only made $100,000 on the profit on the sale of that house, since your basis includes the $50,000 from the rollover, you really have made $150,000 in profit. Prior to the new Tax Reform Act, if you were not going to take advantage of the once-in-a-lifetime exemption, you would have to pay a capital gains tax on the profits -- assuming that you held the property for more than six months. The maximum capital gains tax used to be 20 percent of the profit. Now it is possible that you may have to pay more than 30 percent tax of any profit.
However, to complete the great American Dream cycle, several years ago Congress enacted a once-in-a lifetime senior citizen exemption, whereby the first $125,000 of profit is completely exempted from income tax.
In your case, since you have clearly lived in the property for three of the last five years, you would have to sell your property within two more years from the date you purchased the new house in order to obtain the once-in-a-lifetime exemption.
These dates are statutory and cannot be extended.
However, you should seriously consider whether this is the time to take the exemption. If, for example, you are planning to purchase a new house whose value is equal to or greater than the value of your current house, you can still exclude much of the profit for tax purposes without resorting to the senior citizen's exemption. You can roll over the profit, and still defer the tax on this profit until you sell your last house.
If you are moving to an area with potential growth and where houses may be appreciating significantly, perhaps you should wait to take the senior citizen exemption when you sell that next house. Remember, this is a once-in-a-lifetime exemption, and you should plan carefully now to preserve all of your options.
Unfortunately, tax planning must now play a significant role in all of our lives. Discuss the facts with your tax advisers before you make any major decisions. Benny L. Kass is a Washington attorney. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed, stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.