New Tax Breaks For Home Sellers
By Julian Block
A revamping of the Internal Revenue Code in 1997 included provisions that significantly revise the tax breaks for real estate, particularly the way home owners figure the taxes on sales of their dwellings. The legislation liberalizes and simplifies the rules for sales after May 6, 1997, the date the changes took effect.
The good news is a phenomenal break that relieves the vast majority of homeowners of all capital-gains taxes on sales of principal residences, whether houses, condos, or co-ops. The bad news is a drastic hike in taxes for many sellers in expensive housing markets.
What the home-sale rules now generally allow is an “exclusion,” meaning escape from taxes, on a profit of as much as $250,000 for those who file single returns and double that amount -- a full $500,000 for joint filers. Remember, that's profit, not sales price.
No longer need sellers be concerned with regulations that allow them to defer taxes on their past gains only if they purchase a replacement residence that costs more than what they received for the one sold and do so within two years. Nor do they have to wait until attaining age 55 to permanently exclude up to $125,000 of gain without having to buy another dwelling. Under the new rules, it matters not how old the sellers are or whether they buy a cheaper replacement or even go into rentals.
Unlike the old once-in-a-lifetime exclusion, the new exclusion is not a one-time opportunity. You get to claim it as often as every two years, provided you have owned and lived in the property as your principal residence for at least two out of the five years before the sale and at least two years have elapsed since you last used the exclusion.
What follows is a close look at the new, any age, bigger bucks exclusion that trims taxes for most homeowners, but raises them for some, along with reminders on how to exploit the opportunities and avoid the pitfalls that Congress and the White House have strewn in your path.
As is true of all tax legislation, 1997’s version of reform helps some individuals and hurts others. What happens when the envelopes are opened? The biggest winners are people who want to sell and relocate from expensive housing markets like San Francisco or New York to less expensive areas like Tampa, Fla., or Tucson, Ariz., or become renters, perhaps because they are "empty-nesters" -- the folks whose children have moved out and left them with houses that are too big and too expensive to maintain. Others benefited include those near retirement or compelled to sell because of job switches, health problems or financial setbacks.
The changed rules are a boon to downsizers, adding flexibility to their financial planning. They can sell their dwellings for sizable gains, switch to smaller quarters and the lower maintenance expenses that go along with it, and channel their inflation-swelled profits, undiminished by taxes, into business ventures or into retirement funds to supplement Social Security benefits.
Another option is to use some of the freed-up funds for gifts of money, stocks and the like, so as to shift income from themselves to family members and others in lower brackets, as well as reduce the value of assets subject to onerous estate taxes that fall due at death.
Among those with nothing to cheer about: sellers in areas where property values have increased dramatically or who have accumulated gains (profits from before-May-7-1997 sales that they sheltered by trading up to more expensive houses) above the exclusion amount. The IRS duns them for long-term capital gains taxes at a maximum of 20 percent on anything over the threshold of $250,000 or $500,000.
Gone, as mentioned earlier, are the rules that allowed them to adroitly sidestep all taxes simply by reinvesting the sales proceeds in a replacement or, because of a sale after age 55, completely escape tax on as much as $125,000 of profit.
For tax year 2002, the top rate for long-term gains is 20 percent for sales of principal residences and most other investments owned more than 12 months. The top rate drops from 20 to 10 percent for those in the lowest bracket of 10 and 15 percent for income taxes. The 10 percent rate drops to 8 percent for gains from sales of principal residences, individual stocks, mutual fund shares, and most other investments owned more than five years.
All is not lost if you anticipate a gain greater than the exclusion amount of $250,000 or $500,000 and also suffer some losses on investments in stocks, fund shares, and the like. A long-standing provision allows you to offset the taxable part of the gain with investment losses that are not otherwise currently deductible because of the ceiling of $3,000 in any one year on the amount of net capital losses that can be deducted from "ordinary income," IRS lingo for such income sources as salaries or other compensation, dividends and interest.