Taxes and Gain

What is the Tax Exclusion Rule for the Sale of a Residence?

The Taxpayer Relief Act of 1997 has replaced the old Rollover Residence Replacement Rule, IRS Code Section 1034, which allowed you to avoid paying tax on your profit from the sale of a principal residence so long as you bought a replacement residence within 24 months before or after the sale. It also replaces the old IRS Code Section 121 which allowed for a one-time exclusion to sellers who were over 55. The act applies to all sales on or after May 7, 1997, and allows a $250,000 ($500,000 for married couples) exclusion from the tax on the sale of your principal residence. You no longer need to buy another house of equal or greater value to claim the exclusion.

There are a few guidelines you need to follow to take advantage of this ruling. You may use it repeatedly but not more frequently than once every two years. The property must be your principal residence, not a second residence or a rental property. The residence may be in or out of the United States. It may be a detached house, a mobile home, a co-op apartment, or a condominium. You cannot have more than one principal residence at the same time.

There is a special provision in this 1997 Tax Act which allows both spouses to claim up to $250,000 of tax-free profits, even if one spouse is not living in the residence. For example, if an ex-spouse lives in the family home for at least two of the five years before the sale, then the nonresident spouse can also qualify for up to $250,000 of home sale tax exempt profit. There is also a special provision for a surviving spouse. The surviving spouse is allowed to claim up to $500,000 of principal residence sale tax exempt profit if the home is sold in the year of the other spouses' death. In the event where two or more unmarried co-owners each meet the ownership and occupancy requirements, each co-owner may also claim up to $250,000 of tax exempt profit when the home is sold.

This exclusion virtually eliminates most record-keeping requirements when you know for certain that you will not experience a gain of more than $250,000 ($500,000 for married couples) on the sale of your residence. Your escrow or title company is no longer required to file Form 1099-S, which reported these qualifying home sales to the IRS. The new act did not change the rules concerning a loss on the sale of your residence. If there is a loss, it is still not tax deductible.

Related Question

What are the rules if I acquired my residence in a like-kind exchange?

As of October 22, 2004, the American Jobs Creation Act of 2004 does not allow any tax exclusion if you sell your home within five years in the case where you have acquired the property through a like-kind exchange. Normally, a taxpayer would be allowed a tax exclusion of $250,000 ($500,000 for married couples) deduction if the property was used as a principal residence for at least two out of the five years before the sale. Taxpayers who convert rental property to a principal residence should be aware of this tax law change, which could limit their ability to exclude the gain on the sale of the residence.

How Do I compute my Gain on the Sale of My Property?

First figure the (adjusted)cost basis=B

 (Puchase Price of the Home + Closing Costs (except points on new loan)+ Improvements while you own it.)

Improvements do not include paint and maintenance. It has to be an actual improvement(remodeling kitchen, new deck, etc.)

Then figure the actual sale when you sell =A

(Actual sale price -  brokerage commission)

A - B = Your Gain on Property.

**Points on a new loan, mortgage interest, and real property taxes are deductions from income and therefore do not figure into calculating gain realized on the sale of your home.**

Hopefully, you've lived in the property as your main residence for at least 2 of the last 5 years prior to selling your property, so you can enjoy that 250K/500K gain exclusion from taxes.

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