Tax Resources:

Home Sales Strategies
By Julian Block

A recent tax code revision generally allows couples filing jointly to “exclude,” meaning escape from taxes, as much as $500,000 in gain on the sale of a "principal residence”-- IRS lingo for the place you live most of the year, as opposed to a vacation dwelling or property for which you charge rent. For single filers, the exclusion cap is $250,000.

Remember, that’s profit, not sales price. This break went on the books for sales after May 6, 1997.

And if you reap a profit greater than the exclusion threshold of $500,000 or $250,000? You are stuck with taxes on the excess. But the maximum rate is 20 percent for a long-term capital gain, plus applicable state income taxes.

You are able to claim the exclusion as often as every two years. To qualify, you must own and live 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.

Married Couples

For a married couple to qualify for the full $500,000 exclusion, either one can satisfy the ownership test, but both must pass the use test. The exclusion cap drops from $500,000 to $250,000 if either spouse claimed the exclusion for a home sale within the previous two years.

TIP The once-every-two-years restriction does not preclude a couple filing jointly from each excluding up to $250,000 of gain from the sale of each spouse's residence, provided that each spouse could exclude up to $250,000 if they filed separately.

The IRS bestows this gift on newlyweds who both own homes that they sell before or after their trip down the aisle. On their joint return, each can exclude as much as $250,000.

CAUTION. To get the exclusion of $500,000, the residence must be sold during a year that a couple can file a joint return. That includes the year the seller's spouse dies. So a spouse considerate enough to die on January 1 gives the surviving spouse until December 31 to sell and exclude $500,000.

What if a spouse unconcerned or unaware of the rules dies on December 29? The $500,000 exclusion would remain available only if the survivor could sell in two days.

Fortunately, the surviving spouse need not fret just because the sale takes place in a post-death year, which means an exclusion cap of no more than $250,000. The IRS has a condolence gift for the survivor: a "stepped up" basis for the deceased spouse's half interest, assuming the couple own the property in joint ownership with the right of survivorship. (If they do, this means that on the death of one spouse, the other inherits a half interest and automatically becomes the owner of the entire interest.) Put another way, the deceased's half interest is stepped up from its original cost to its value on the date of death.

TIP. In my experiencing advising clients, the step up in basis is often overlooked by the typical couple who own their home in joint tenancy with the right of survivorship.

EXAMPLE. Some years ago, Adam and Alice bought their home for $150,000 and added improvements of $50,000. Their home has a basis of $200,000 and is worth $600,000 at the time of Adam’s death. Alice’s stepped-up basis becomes $400,000 -- the sum of $100,000 (her half of the $200,000 original basis), plus $300,000 (half of the $600,000 date-of-death value).

Suppose Alice later sells the home for a net sales price (after a reduction for all allowable sales expenses, such as a broker’s commission and legal fees) of $700,000. With a basis of $400,000, she has a gain of $300,000. Her exclusion erases taxes on $250,000 of the gain.

CAUTION. The 2001 tax act partially repeals the step-up in basis. But that change does not take effect until after 2010 and applies only to individuals who die in 2011 or later and leave large estates. Moreover, federal budget deficits are going to be swelling in coming years. So, like the eventual repeal of estate taxes, step-up's abolition might not ever happen.

Loophole for Nonmarrieds. As much as $500,000 can be tax-free on the sale of a residence owned jointly by individuals who are not husband and wife -- for example, a parent and child, a brother and sister or an unmarried couple sharing quarters without a marriage certificate. As long as each unmarried joint owner passes the ownership and use tests, each one gets to exclude up to $250,000 of his or her share of the profit.

Divorce and Separation

The revised rules also benefit couples who split up. A couple who decides to divorce or legally separate can file separate returns and each exclude as much as $250,000 of the profit from their home sale.

CAUTION. Unsurprisingly, even a tax change touted as simplification has a complex side. The seemingly straightforward exclusion is going to complicate the division of homes and other assets in many divorce settlements and boost billable hours for attorneys and accountants with matrimonial practices. Here are some examples.

New break when one spouse is awarded use of the home but both still own it. The old rules routinely sprung a trap when, as is common, one of the spouses moved out of the dwelling and retained sole or joint ownership. In most cases, the husband was the one who departed. Unlike the wife who stayed put, he was stuck with taxes on his share of the gain. The reason: By the time the sale occurred, the place was no longer his principal residence.

The new rules correct this inequity. The ex-husband gets the exclusion for his share of the gain when he remains an owner and a divorce or separation agreement grants the ex-wife use of the home and she lives there for at least two years before the sale. It makes no difference that the sale takes place years after the divorce.

Some more fine print helps the ex-wife in this standard scenario. Suppose the ex-husband ceases to be a joint owner because the divorce or separation agreement awards the entire ownership to the ex-wife. Then the law considers her to have owned his former interest in the home for the same amount of time as he did. So she should be able to sell immediately and claim her exclusion of $250,000 for the entire interest in the home, rather than waiting until she owns his former interest in her own name for at least two years. That assumes the ex-wife satisfies the use requirement.

Additional Resources
The following Special Reports are also available for purchase. Please read the press reviews about these reports below. To purchase a Special Report click on the link.

Learn more about the Author of these publications, Julian Block

Press Reviews
- "Provides more depth than the other books" The Wall Street Journal
- "Easily the best available" Forbes
- "Offers numerous short money-saving tips, as well as sophisticated strategies... one of the best books... New York Times
- "Block's book covers all the bases on tax planning... The language is easy to understand and the examples are plentiful" New York Daily News