Sale of Your Home
By Peter Jason Riley
tax treatment of gain on the sale or exchange of a principal residence has
drastically changed as a result of the Taxpayer Relief Act of 1997 (note,
however, that you still may not deduct any losses suffered on the sale of
your home). The new home-sale gain exclusion rule replaces the old "rollover"
rule that allowed homeowners to defer paying tax on the gain on the sale
of a principal residence if they reinvested the sale proceeds in a new home
of at least equal value within two years of the sale. The new rule also
replaces the well known once in a lifetime $125,000 exclusion that was available
for taxpayers age 55 and over who sold their homes.
Under the new home-sale exclusion rule, you may be able to exclude a portion,
or possibly all, of the gain realized from the sale of your home if your
home met the principal residence rules. During the five-year period ending
on the date of the sale you must have owned and used the property as your
principal residence for a period aggregating two or more years. You need
not have lived there continuously to qualify. You may use the exclusion
as many times as you wish, provided the eligibility requirements are met,
but generally no more frequently than once every two years.
The amount of the exclusion is limited to $250,000 for single individuals
and married individuals filing separately. The exclusion is increased to
$500,000 in the case of married couples filing a joint return, where at
least one spouse meets the ownership requirement, both spouses meet the
use requirement, and neither spouse is ineligible for the benefits because
he or she excluded gain on the sale or exchange of a home under the new
provision within the past two years. If a taxpayer marries someone who is
ineligible, the taxpayer generally remains eligible for a maximum exclusion
The gain being excluded is the difference between the purchase price plus
improvements and the selling price less closing costs. For example if Mary
buys her house for $250K and then makes $25k in improvements her cost basis
is now $275K. If, after 4 years, she sells her home for $400K and incurs
closing costs and commissions of $27K her net proceeds are $373K ($400K
- $27K). Her gain is $98K ($373K - $275K). As a single individual she will
be able to exclude the entire gain of $98K regardless of what she does with
the proceeds because the gain is less then $250K.
If you fail to meet the ownership and use requirements due to a change in
place of employment, health, or other unforeseen circumstances, you may
exclude a fraction of the $250,000 ($500,000) amount. In other words, you
can take a ratio of the exclusion based on the percentage of the 2 years
you have lived in the home. For example, if the taxpayer has only lived
in the house for 1 year and the move is due to an "unforeseen circumstance"
such as a job change they are eligible to use half of the gain exclusion
Special rules apply in determining ownership and use if you are receiving
out-of-residence care, inheriting property from a spouse, transferring property
pursuant to a divorce, or disposing of property where the rollover rules
The new exclusion rule also generally applies to the sale of a remainder
interest in a principal residence, if all the other requirements are met.
Thus, you may retain a life estate in your home while selling the remainder
The new exclusion rule requires gain recognition to the extent of any depreciation
taken after May 6, 1997, for the rental or business use of your home. In
such cases, the gain will be subject to a special capital gain rate of no
greater than 25%.
The home-sale gain exclusion provision applies to sales of a principal residence
occurring after May 6, 1997. You may elect, however, not to have the new
exclusion provision apply to any sale or exchange (in such cases, gain recognition
generally is required and the prior law rollover and one-time exclusion
provisions cannot be applied).
You may elect to apply the former rollover and one-time exclusion rules,
and not the new home-sale gain exclusion rule, to certain transition period
sales occurring: (1) before August 5, 1997; (2) after August 5, 1997, if
it is pursuant to a contract which was binding on August 5, 1997; (3) after
August 5, 1997, if gain would not be recognized under the former rollover
rule because a replacement residence was acquired on or before August 5,
1997 (or pursuant to a binding contract in effect on August 5, 1997).
With the repeal of the rollover rule, you are no longer required to purchase
a replacement residence within strict time limits in order to defer (rollover)
any gain realized on the sale or exchange of your home. You are also no
longer required to split the basis in your home between that portion used
as a principal residence and the portion used for rental or business purposes
as was required under the rollover rule. The present exclusion rule is a
significant improvement over the age 55 or over exclusion, not only because
it is available to taxpayers of all ages and allows a greater exclusion,
but because it can be used repeatedly and one spouse is not denied the benefit
of the exclusion just because the other spouse had elected to exclude gain
on the prior sale of another residence.
There is a downside to the repeal of the rollover rule if you have a gain
in excess of $250,000 ($500,000 if married filing jointly) when you sell
your home. Instead of being able to defer the gain by buying a more expensive
home, as under prior law, you will now be liable for income tax on the excess
gain in the year of sale. In these circumstances, application of prior law
would result in a lower tax liability, provided you are able to apply one
of the transition rules discussed above. However, if you owned your home
for at least 12 months, the excess gain will be subject to a significantly
lower capital gain rate of 15%.