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IRS Finalizes House Sale Regulations
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In one of the biggest gifts ever to American homeowners, Congress in 1997 passed The Taxpayer Relief Act, a portion of which changed long-standing rules for, and provided a huge break on capital gains taxes on the sale of a principal residence. The Internal Revenue Service has, at long last, finalized the regulations regarding one aspect of that law; how to treat sales that occur outside the two year/five year requirement. The new rules were effective as of August 13, 2004.
Most savvy homeowners probably know The Taxpayer Relief Act by heart, but, for the benefit of persons new to actual or potential homeownership, a quick review.
Homeowners had almost always had the ability to defer paying capital gains tax if within a given period of time they purchased a home more expensive than the one they had sold. A homeowner could keep rolling these capital gains over into new properties virtually forever. But, prior to 1997, there was only one small loophole when it was time to cash out. If at least one owner of a house had obtained the age of 55, then $125,000 in profit from the sale of that, (and all the prior houses) could be excluded from capital gains taxes.
In a day of phenomenally increasing house values, the threat of taxes on profits over $125,000 sometimes made it impossible for a homeowner to downsize to a condominium or even to move in with children or into supportive care. The situation was even worse if the homeowner had refinanced over the years, leaving little actual cash to come out of the sale. Homeowners also had to keep records of capital improvements on all homes that had been excluded from capital gains by the "buying up" loophole.
The Taxpayer Relief Act changed this A single homeowner can now exempt $250,000 in capital gains from the sale of a principal residence ($500,000 for a married couple or "certain taxpayers" filing a joint return) providing only that the homeowner had occupied that home as a principal residence for two of the five years preceding the sale. And this can be done over and over again - as long as a sale does not occur more than once every two years.
While historically low interest rates have been given much of the credit for the booming housing market, there can be little doubt that this new tax law has done a lot to encourage homeowners to speculate in the housing market - if you love to renovate and don't mind living in a mess, handy-man specials can now provide a full time job - and that it has encouraged the growth of retirement and luxury condominium developments.
But, what Congress gives, the IRS can always take away. And left definitively unanswered since passage of the law is the tax liability of a homeowner who sells a home after owning it for only 12 or even 23 months, or is unable to meet the two out of five year residence requirement.
The IRS published temporary regulations regarding this issue in the Federal Register on December 24, 2002. While some written and other comments were received, no public hearings were requested, and the Treasury Department has now finalized, with some changes, those temporary rules.
The main change is a further exemption for military and foreign service personal that allows them to extend the two out of five year residence period to a total of ten years. Therefore, if a military family owned and lived in a residence for three years and then were sent on temporary assignment to another state for six years, they could extend the clock forward so that two of the three years in residence still fall within the requisite time period, (which would then be eight years.)
The rules regarding other sales that do not meet the basic 2/5 criteria can be summarized fairly simply. If you have to sell your house, you are probably entitled to a partial exemption from capital gains taxes; if you just want to sell, get out your checkbook.
The three underlying reasons for qualifying for an exclusion are:
- A change in employment
- a change in health
- unforeseen circumstances.
The acceptable parameters for changes in health or employment are fairly straightforward. In the case of health, the allowable reasons for an early sale are to "obtain, provide, or facilitate the diagnosis, cure, mitigation or treatment of disease, illness, or injury…or to provide or obtain medical or personal care for a qualified individual suffering from a disease, illness or injury." There must be a specific illness; deciding that an ocean view would make one feel a lot better will not suffice.
Permissible employment changes include new employment, continued employment, and the commencement or continuation of self-employment. A 50 mile rule generally obtains, i.e., that the new place of employment is at a distance at least 50 miles farther from the principal residence than the prior place of employment.
Unforeseen circumstances are a little squishier. The regs further define them as "an event that the taxpayer could not reasonably have anticipated" before purchasing and occupying the residence. There is a laundry list of events, including involuntary conversion of the residence (a taking by eminent domain), natural or man-made disasters, death, loss of job that would qualify the homeowner for unemployment compensation; selected other serious financial reverses; and multiple births resulting from a single pregnancy. In some cases divorce qualifies, but marriage does not appear to do so. The final regulations further state that the "unforeseen" cannot be a sudden preference for a different residence or an improvement in financial circumstances.
The IRS has set forth a number of "safe harbor" exemptions which further define (and quite clearly, considering the source) how they can be applied. Qualifying for any of these will allow a taxpayer to take a partial exemption based on the percentage of the two year requirement he owned and/or occupied the house. For example, if a homeowner sold a home after occupying it for 15 months and met one of the safe harbor provisions, he would calculate his exclusion from capital gains tax according to the following formula:
(250,000/ 730) x (15 x 30.42)
where $250,000 is the full exclusion (or $500,000 in the case of a qualified spouse); 730 is two years expressed in days, and 30.42 is the average number of days in a month. In this instance, a homeowner would be able to exclude $156,267 of the proceeds of his sale from capital gains tax.
If none of the safe harbor provisions apply, there is also the alternative of applying to the IRS for a ruling based on special circumstances. Consider, however, that it might make more sense to remain in the home for the remainder of the two year term rather than tussle with that agency.
To read the revisions and all of the safe harbor provisions in their entirety, go to www.irs.gov/pub/irs-regs/td_9152.pdf.
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Comments (21)
| If we want to qualify under the safe harbor clause of change of employment, can we sell our house before the new employment begins or does it have to be after the commencement of the new employment (50 miles away)? The reason for this question is bec we want to have enough time to sell the house and make the move rather than move then sell the house afterwards and end up with a mortgage and a rent. |
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| Above Posted By:
Gerry
| Mon, 2 Apr 2007 17:04:41 EST |
| We recently sold our home and were pressed to buy another one right away. We really bought this home for an investment but we listed it as primary residence because we planned to live here at least 2 years minimum. I now am told that my job requires me to transfer which involves more than a 50 mile radius. My question is, if I sell my home and buy another one putting all profit back into another home, can I avoid paying any taxes on this new purchase? |
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| Above Posted By:
Michael
| Thu, 26 Oct 2006 09:48:56 EST |
| Can replacement residence be purchased before sale of old residence? If so, how soon must sale of old residence be made? |
|
| Above Posted By:
Richard
| Wed, 20 Sep 2006 12:25:56 EST |
| My house is in my name alone and I have lived here for 50 years. If I put the house into a revocable trust will I be able to sell it within the next year and still be able to take advantage of the capital gains tax or will I have to stay in the house another 2 or 3 years? |
|
| Above Posted By:
Bree
| Tue, 5 Sep 2006 07:30:46 EST |
| I am a widower, and I'm going to remarry in six months. Do I have to sell my current principal residence which I have lived in for the past 11 years prior to my forthcoming marriage so that my future wife will also be eligible for the $250,000. Exemption when she sells her home at some future date? We are going to live in her home after we marry. |
|
| Above Posted By:
John
| Wed, 5 Jul 2006 11:38:11 EST |
| We owned a house in Mississippi (in the Hurrican GO Zone) and sold it after 8 months because of damage AND my husband was moved by the military from New Orleans to Pascagoula, Mississippi, a distance of about 125 miles...we made $36000 profit and put 100% of it into a new house that cost more than the old house. Do we have to pay capital gains tax? |
|
| Above Posted By:
Nicola Perry
| Mon, 17 Apr 2006 09:38:01 EST |
| Anon Terry, I would like to know the answer to your question as well. |
|
| Above Posted By:
John
| Wed, 12 Apr 2006 17:10:32 EST |
| anon terry was your question answered? |
|
| Above Posted By:
nancy
| Mon, 10 Apr 2006 22:13:18 EST |
| Please explain the number of years a homeowner is exempt
from paying capital gain on the sale of a home. I have rented my home and would like to sell it. Does the five year clause begin at that point, or pryor to the renting of the home. I rented the home in Aug.2003 I had lived in the home for 22 years before renting. Does capital gain mean that I do not have to pay taxes on the money received from the sale of the home. |
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| Above Posted By:
mirian hill
| Tue, 4 Apr 2006 11:53:48 EST |
| For example, I bought my primary residence for $100,000. I then sell the home for $200,000. Then, I buy another home to be my primary residence for $250,000. Is the $100,000 appreciation from the sale considered a capital gain? If it is, what is my tax liability? |
|
| Above Posted By:
Robert Fisak
| Mon, 3 Apr 2006 14:00:35 EST |
| I lived in a home that the owner and I had an agreement of rent to own by hand shake. I finally had enough to buy it, but 4 months after the closing a land developer offerd to buy at 1 12 times the purchase price. Since I lived in it for 9 years under rent to own, does that count to the 2 year exemption? |
|
| Above Posted By:
todd
| Sun, 12 Mar 2006 12:38:21 EST |
| If the owner of a revocable trust dies, do heirs to a house that is in that trust have to pay capital gains taxes when the house is sold? |
|
| Above Posted By:
Ken
| Sun, 26 Feb 2006 17:25:26 EST |
| When does the homeowner exemption from capital gain
expire, if not extended by Congress? |
|
| Above Posted By:
Anon Terry
| Sat, 25 Feb 2006 15:43:01 EST |
| My husband and I owned our house for about 10 months and then we sold it because he was being stationed in Iraq for a period of time. I want to know if we're considered exempt bc of his orders. We made a profit of about $54,000.00. If we are exempt, do we still report the sale of our home? I recently seeked professional help from H & R Block and they said I simply don't submit any form stating the sale of my home. Is that right??? |
|
| Above Posted By:
Jamie
| Mon, 6 Feb 2006 20:54:00 EST |
| I would like to know what form I fill out for the exclusions because I have lived in my home for 8 months and I am moving for new employment more that 50 miles away.
I am selling the house and I will make $43000. |
|
| Above Posted By:
Mike Quenneville
| Mon, 6 Feb 2006 10:59:10 EST |
| What are the rules for selling a beach 'second home' that has been owned by us for the past 35 years. We just can't afford to keep two houses anymore. |
|
| Above Posted By:
JOAN DIXON
| Sun, 8 Jan 2006 23:28:20 EST |
| I sold my house with a capital gain of $400,000. I am single.
What is the tax shelter for the $150,000? |
|
| Above Posted By:
badara
| Sun, 8 Jan 2006 14:22:01 EST |
| 61 year-old woman owns condo. She dies and condo passes to son via a living trust. Trustee sells condo and gives the 270 K in net cash proceeds to son as dictated by the trust. Son, who married 6 months before his mother died, had lived in condo with mother but he had been away at college for last 5 years before the sale. Son came home to condo when college was not in session and still received most mail at the condo. Does son owe any taxes on the sale? If so, how much? |
|
| Above Posted By:
anonymous
| Wed, 21 Dec 2005 14:47:50 EST |
| Husband dies in 2005 and house sells for over $400,000 (much the same as the previous comment). Is there any time line for being able to sell and still get the $500,000. untaxed? |
|
| Above Posted By:
Cindy
| Thu, 17 Nov 2005 10:20:20 EST |
| Husband dies in 2005 and wife sells home with more than $400,000 in capital gain. Can she file a joint return and have no capital gains tax due? |
|
| Above Posted By:
Wayne Whitehead
| Tue, 6 Sep 2005 17:52:02 EST |
| What if the residence is outside of the US? Does it qualify for the $250,000 exemption? |
|
| Above Posted By:
Anonymous
| Mon, 4 Apr 2005 11:12:47 EST |
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