Reducing home loan offers guaranteed rate of return
It’s been nearly 20 years since a slicker, reusable model replaced the one-time capital gains exclusion on the sale of one’s principal residence, yet the new law still perplexes many older home sellers. In fact, the topic could be listed at the top of any “I don’t get it” category.
For example, two callers to a recent radio talk show asked if they could roll some of the profit from the sale of their primary residence into their new home to thereby avoid paying capital gains tax on the profit.
The simple answer is you don’t have to worry about a tax liability if your gain is $500,000 (married couple) or $250,000 (single person) or less. And, there is no blending of the previous and current programs.
When the Taxpayer Relief Act of 1997 was signed into law on Aug. 5, 1997, it changed not only the $125,000, one-time home sale exclusion for persons over 55 years of age, but also the rollover replacement rule. In essence, the home began to move from the shelter column into the financial portfolio column.
To qualify for the $500,000 exclusion ($250,000 for single persons), you must have owned and used the property as your principal residence for two out of five years prior to the date of sale. Second, you must not have used this same exclusion in the two-year period prior to the sale. So, the only limit on the number of times a taxpayer can claim this exclusion is once in any two-year period.
What is often misunderstood is that both the earlier one-time exclusion of up to $125,000 in gain for persons over 55 and the deferral of all or part of a gain by purchasing a qualifying replacement residence has been eliminated. You no longer can utilize parts of either portion and you absolutely do not have to buy a replacement home. Persons who used the $125,000 can make use of the current exclusion if they meet the two-year residency test. The law enables all consumers to buy down to less expensive homes without tax penalties.
Under the old law, a taxpayer could defer any gain on the sale of a principal residence by buying or building a home of equal or greater value within 24 months of the sale of the first home. Tax on the gain was not eliminated, but merely rolled over into the new residence, reducing the tax basis of the new home. If you sold a primary residence and failed to meet the requirements for deferral, the taxpayer faced a tax on current and previously deferred gain.
The intent of the new tax code, which replaces the rollover provision and $125,000 over-55 exclusion, is to allow most homeowners to sell their primary residence without tax. It also dramatically simplifies record keeping for many. Although it’s still wise to retain proof of the original cost of the home and significant improvements, tedious collection and retention of invoices and other records to substantiate the cost of improvements probably won’t be necessary.
While some homes in the heartland of the U.S. had not appreciated at the rate of coastal areas like Seattle, San Francisco, Boston, New York, Miami and San Diego, the one-time over-55 $125,000 exclusion was absolutely in need of a makeover. Before 1997, the tax-free amount was last raised to $125,000 from $100,000 on July 20, 1981 — 16 years of the same benefit while some homes had tripled in value during the same time.
The exclusion, which had jumped from $20,000 to $35,000 in 1976, then to $100,000 in late 1978, was terribly out of date and had not kept pace with inflation. Homeowners, especially retired folks, need more incentive to be mortgage-free. The one-time, over-55 exemption was becoming more of a one-time problem. Buying down had begun to carry the connotation of losing out.
Many taxpayers, including some seniors who have already used the one-time over-55 $125,000 exclusion, often do not realize they are still eligible to sell their primary home again, and do it every two years, under the Taxpayer Relief Act of 1997. The 1997 law repealed all former tax laws on primary residences.
And, it is already nearly 20 years old.
Tom Kelly, former real estate editor for The Seattle Times, is a syndicated columnist and talk-show host.
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