1997 Tax Provisions Affect the Sale of Your Principal
The tax bill signed by the
President on August 5, 1997, provides substantial benefits to taxpayers who sell their
principal residence. The Questions and Answers in this document are intended to provide
basic guidance to sellers on issues that are covered by the federal statute. Since
becoming law, some issues have received further clarification, so guidance from a
competent tax advisor is essential. The following is taken directly from information
provided by the National Association of Realtors.
1. What is the
new $500,000 exclusion?
This new exclusion replaces
and greatly expands the old $125,000 one-time exclusion allowed for taxpayers who were age
55 or older. The amount has been increased to $500,000 for married taxpayers who
file a joint return; the exclusion for taxpayers who do not file a joint return is
$250,000. You can now claim this exclusion every 2 years, and you do not
have to buy a new residence.
2. Do I have to
be a certain age to claim this exclusion?
Under old law, you had to be age 55 before the date of sale in order to claim the $125,000
exclusion. The new exclusion does not impose any age restrictions, so any seller is
3. How do I
qualify for this exclusion?
You must satisfy three tests,
each of which contains a 2-year requirement:
- You must have owned the residence for periods aggregating at least 2 years of the 5-year
period, ending on the date of sale.
Use Test -
You must have used the property as your principal residence for periods aggregating at
least 2 years of the 5-year period ending on the date of sale.
Waiting Period Test
- You must not have utilized this exclusion for any sale during the preceding 2-year
4. My spouse and
I have not been married long enough to satisfy any of the 2-year tests. Can we qualify for
the full $500,000 exclusion?
Maybe, provided you file a
joint return for the year of sale and satisy the Ownership, Use and Waiting Period Test,
each of which is slightly different for married taxpayers.
- EITHER you or your spouse must satisfy this test, so you still can claim the exclusion
even if only one of you owns your residence.
Use Test -
BOTH you and your spouse must satisy this test, so each of you must have used the property
as your principal residence for 2 years of the 5-year period ending on the date of sale.
Waiting Period Test
- You cannot claim this exclusion if EITHER you or your spouse sold a principal residence
during the past 2 years that qualified for this exclusion.
5. I have owned
and lived in my residence for over 5 years. My spouse and I were married only last
year, so she has lived in the residence for only a year. Can we claim the $500,000
exclusion even though she has not used this house as her principal residence for 2 of the
last 5 years?
NO. Both of
you must meet the 2-year Use Test. There is no exception to this rule for newly-married
6. Can I still
claim the $250,000 exclusion even though my sponse does not satisy the Use Test?
The law is written so that the exclusion is increased to $500,000 if a married couple
files a joint return and satisfies all of the Ownership, Use and Waiting Period
Tests. If either of you fails the Use Test or the Waiting Period Test, you cannot
claim the $500,000 exclusion, but would qualify for the $250,000 exclusion. (Note:
As discussed above, only one of you needs to satisfy the Ownership Test.)
7. I transferred
ownership of my principal residence to my revocable living trust over 5 years ago, so
technically, I do not satisfy the ownership test. Can I still claim this exclusion?
Maybe. The answer to this
question really depends upon the terms of your living trust. The typical "living
trust" arrangement allows the grantor to revoke the trust at any time prior to death
-- and reclaim the assets. The Internal Revenue Service generally considers this
type of arrangement to be a "grantor trust," and treats the grantor as the owner
of the trust property and income. (Please check with your tax advisor for further
clarification and guidance.)
8. Do I have to
purchase a replacement residence in order to claim this new exclusion?
NO. YOU ARE NOT
REQUIRED TO PURCHASE A REPLACEMENT RESIDENCE!
9. Can I claim
this exemption more ofter than every 2 years?
Under very limited circumstances, you are entitled to a percentage of the
exclusion even if (a.) you have not owned your residence for 2 years, or (b.) it
has been less than 2 years since you sold another principal residence. These special
crcumstances include a change in your place of employment or health.
Also, the new law directs Treasury to issue regulations to provide the same
treatment for sales made due to "unforeseen circumstances."
10. Does the new
law allow me to deduct a loss on the sale of my principal residence?
Losses on the sale of your principal residence remain non-deductible.
11. If my gain
is less than $250,000 ($500,000 for qualifying married taxpayers), can I apply the unused
portion to a future sale?
unused portion simply disappears. However, you will again be eligible for the entire
exclusion 2 years after you sell your current residence.
12. How do the
exclusion and the lowered capital gains tax rates related to each other?
If you qualify for the
exclusion, the first $250,000 ($500,000 for qualifying married taxpayers) of gain on the
sale of you principal residence is not taxable; any gain that exceeds this exclusion is
subject to tax at capital gains rates in effect on the date of the sale.
13. If my gain
is taxable, what is the new tax rate?
Effective May 7, 1997, the new
rules reduce the capital gains tax rate from 28% to 20% (10% for taxpayers in the 15% tax
bracket). (Please consult with your Tax Advisor for changes in these.)
14. If I already
used the one-time $125,000 exclusion for a residence I sold before May 7, 1997, can I
still claim this exclusion?
Yes. Your eligibility
for the new $500,000 exclusion is not affected by whether or not you claimed the old
15. My brother
and I and one of his friends own a home together that we use as our principal residence.
Each of us is single. How will the new exclusion affect us when we sell the
Each of you will qualify for
an exclusion up to $250,000. Thus, as much as $750,000 of gain on the sale could be
excluded from tax. Since each of you files your tax return as a single person, each
of you will qualify for your own exclusion on your portion of the gain.
16. My spouse
died this year, and now I want to sell our principal residence. Can I claim the $500,000
Maybe, but in order to qualify
for the full $500,000 exclusion, you must sell your residence during the same tax year in
which your spouse dies. The reason for this is that you are allowed to claim the
$500,000 exclusion only if you file a joint return, and after the death of your spouse,
you are permitted to file a joint return only for the year of death. If you sell in
a later year and file a single person return, you qualify only for a $250,000 exclusion.
17. I bought my
house in 1990 and plan to sell it soon. How do I determine my basis for measuring
gain when I sell?
The starting point is your
purchase price for the residence when you bought it in 1990. If you rolled over gain
from the sale of a prior residence, you must subtract any gain that you realized and
deferred from earlier transactions. If you did do a rollover, you should review the
Form 2119, "Sale of Your Home," that you filed with your tax return for the year
you sold your earlier residence. That form will show the adjusted basis of your current
residence after rollover of the earlier gain.
Whether you start with the
actual purchase price or an adjusted basis as determined in a prior rollover transaction,
your basis is increased by adding the cost of major improvements or special tax
assessments and subtracting any depreciation (e.g., which you might have taken as a prior
home office deduction.) The instructions for Form 2110 include a detailed worksheet to
help you determine your correct basis.
18. I sold my
house in 1998 and qualified for the $500,000 exclusion. I bought a new house for
$150,000, and plan to sell it soon as I again qualify for the exclusion. How do I
determine my basis for measuring gain when I sell?
Your basis will simply be the
purchase price of the $150,000 home plus improvements. The fact that you claim the
$500,000 exclusion does not affect the basis of any residence you later purchase.
19. What are the
record keeping requirements?
For federal purposes, you
should maintain records showing the purchase price and any improvements to your residence
for as long as you own the property, and then for 3 years after you file your return on
which you report the sale.
20. My spouse
and I purchased a residence over 5 years ago, lived in it for awhile, then converted it to
a rental property. If we sell this property today, we will have used it as our
principal residence for fewer than 2 of the last 5 years. Can we still claim a
portion of the exclusion?
No. If you fail any of
the tests, you do NOT qualify for any portion of the exclusion except under the special
circumstances noted above (i.e., change in your place of employment or health).
21. My spouse
and I purchased a residence over 5 years ago and lived in it until a little over 2 years
ago. Can we claim this new exclusion even though we do not now use this property as our
Yes. The property does
not have to be your principal residence on the date of sale. The requirement is that you
must satisy the Use Test for 2 years of the 5-year period ending on the date of sale.
So, provided all other requirements are satisfied, you will qualify for the
information regarding home office deductons, prior depreciation on rental property you now
claim as a residence, exclusion percentages for relocation, etc., please contact a
competent tax advisor.