QMy husband and I have lived in our home for many years. Its value has appreciated significantly. We were planning to sell in a few years and move closer to our children. We know that we would be able to exclude from taxes a lot of the profit when the house is sold. Unfortunately, my husband recently had a stroke and has been placed in a nursing home.
Will this new development affect our ability to take the profit exclusion?
AIt appears that you can still take advantage of the full exemption.
If you are married, file a joint income tax return, and have owned and used your house as a principal residence for two out of five years prior to its sale, you can exclude from capital gains tax up to $500,000 of the profit you will make. (If you are single or file a separate tax return you are allowed to exclude up to $250,000 of your profit.)
But there are exceptions to the rule, and one comes into play in your situation. According to the Internal Revenue Service, if, during the five years before the sale of your home, you become physically or mentally unable to care for yourself, and you have owned and live in your home for at least one year, then "you are considered to live in your home during any time that you own the home and live in a facility (including a nursing home) that is licensed by the state."
In other words, because your husband has lived in the house for more than a year, even though he has gone into a nursing home, the two of you will still qualify for the full exclusion of capital gains taxes should you sell the house. That assumes that both of you continue to own the house and that you continue to live in it.
By the way, when the law says you must use the house for two years, that does not mean continuous use. Short absences for vacations or out-of-town job assignments are still counted as periods of use. Even if you rent out your house for two or three years, as long as you can demonstrate to the IRS that you have owned and used the property as your principal residence for the required time, you are eligible to exclude the profit.
People in other circumstances can be eligible for a partial exclusion even if they have lived in a house for less than two of the previous five years. People may be eligible for this "reduced maximum exclusion" if they sell because of a change in place of employment (for example, a new job is at least 50 miles farther from your home); health reasons; or unforeseen circumstances, as defined by the IRS.
The reduced exclusion is equal to the number of days of use times the quotient of $500,000 divided by 730 days. (Note that 730 days is two full years.) If you are single, or do not file a joint tax return, change the $500,000 to $250,000.
Now that your husband is in a nursing home, I recommend that you sit down with your tax adviser. Determine what your profit would be if you sold the property now or within the next few years. Keep in mind that if you owned and sold a house before 1997, you probably used the "rollover" law that applied then. That old law allowed you to defer any profit you had made when you sold your house, but the profit was used to reduce the tax basis of your new house.
Here is an example: You bought a house for $100,000 in 1980, and sold it for $200,000 in 1990. (For this example, I will exclude any costs or commissions that were paid, although for tax purposes you want to include all such expenses.) In 1990, you purchased your current house for $300,000, and now you can sell it for $800,000.
You might assume that you made a profit of $500,000 ($800,000 minus $300,000).
Wrong. Because you deferred $100,000 in 1990 based on the old rollover law, the tax basis of your new house became $200,000, so you now have a profit of $600,000. The profit you made on the first sale reduced the basis of your new house. Even with the full $500,000 exclusion, you would still owe tax on $100,000 of profit.
Once you and your tax advisers have determined what your profit may be when the house is sold, you then have the opportunity to plan your future.
Benny L. Kass is a Washington lawyer. 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.