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Tax Rules Governing Home Sales Are Overhauled

For transactions that occur on or after May 7, 1997, taxpayers who file joint income tax returns can exclude from income up to $500,000 in gain from the sale or exchange of their principal residence. The exemption is $250,000 for a single taxpayer.

Unlike prior law, this exemption is permanent and not just a deferral: There is no requirement for taxpayers to reinvest the sales proceeds of the old residence into a new residence.

In fact, the prior rules in this corner of the tax law have been eliminated. Accordingly, if taxpayers filing joint income tax returns sell a residence for, say $1,000,000 and are fortunate enough to realize a gain of $700,000, $200,000 of the capital gain must be reported as taxable capital gain even if the taxpayers turn around and purchase a replacement residence for more than $1,000,000. Special transitional rules are available to taxpayers who sold property in 1997 who "counted on" the old provisions (these rules are discussed below).

The new rules also replace the onetime $125,000 exclusion that was available to eligible individuals who were 55 or more.

Who qualifies for the new exclusion?

1. A taxpayer must have owned and used the property as a principal residence for at least two of the five years preceding the sale or exchange.
2. The taxpayer can only claim the exclusion only once every two years.

Under certain circumstances, i.e., health reasons or job relocations, a portion of the gain can still be excluded even though the taxpayer does not meet the above stated requirements.

Although the new exclusion applies to home sales on or after May 7, 1997, taxpayers are granted the right to apply prior law in three situations.

• After May6, 1997 and before August 5, 1997
• After August 5, 1997, subject to a binding contract in effect on August 5, 1997
• After August 5, 1997, where a replacement residence was acquired before August 6, 1997, outright or under a binding contract, and the rollover provision would have applied under prior law.

Observation:

The new tax rules will have the immediate effect of eliminating the drudgery of having to accumulate and retain all of the invoices that you receive for home improvements. In addition, most taxpayers can now begin to think about the type of replacement residence they desire without having to concern themselves with tax implications of their decision.