Homeowner’s exclusion on sale or exchange of main home
Monday, June 30th, 2008Homeowner’s exclusion on sale or exchange of main home
Homeowners who sell their residence, as many retirees will, can take advantage of a provision that allows them to exclude some or all of the appreciation from federal (and many states’) income taxation. Following is a brief overview of the homeowners exclusion. Because this provision is complex, talk with a tax adviser (or consult IRS Publication 523) to make sure that you understand how the law might apply to you. Note: We still hear people ask from time to time, “If I buy a more expensive home, can’t I defer paying taxes on all gain?” Or, “Don’t you have to be over 55 to exclude gain from the sale of a home?”
We can understand how some people who have been in their homes for years have had no reason to bone up on the current rules, which particularly benefit homeowners who purchase less expensive homes, as do many retirees. The home sale provision permits taxpayers to exclude from taxation $250,000 ($500,000 for married persons) of gain on the sale or exchange of the taxpayer’s “main home.”
To qualify as a main home, you must have owned the property for at least two years and lived in it for at least two of the five years before the sale. If you have more than one home, the one you live in most is usually the main home.
Other factors can determine what is your main home, including where you work; where family members live, work, go to school, etc.; your mailing address for bills and correspondence; the address on your tax returns, driver’s license, and car and voter registrations; the location of your banks and where clubs or churches you belong to are located. If, as a result of a change in place of employment, health reasons or other “unforeseen circumstances,” you must sell before meeting the two-of-five test, a portion of the exclusion may be available.
How do you calculate the gain against which you can apply the exclusion? First, subtract all selling expenses from the selling price to get the amount realized. Then subtract your “adjusted basis,” generally the cost of the home (including certain costs of the purchase not deducted as interest or taxes) plus improvements to the property that have a useful life of more than one year and are still part of the home.
The IRS permits use of the exclusion by owners of investment property acquired in a like-kind (Code Sec. 1031) exchange who convert the exchange property to use as a main home. You can use the exclusion on an exchange property after five years from the date of purchase.
If you have an investment property, you could execute a tax-deferred exchange, acquiring a property where you intend to retire.
After established the property’s investment use, you could move in and make it your main home.
Once the two-of-five test and the five year requirement for exchange properties are met, then you can sell, apply the exclusion and use the proceeds for retirement or roll a portion or all of the proceeds into another residence. There is no limit to the number of times that you can use the exclusion provided that the ownership and use tests are satisfied each time.
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