Capital Gains Tax

Here are the questions and answers regarding capital gains tax that most homeowners should consider before making decisions on the sale of their residence.

1. How does a seller get to treat the gain made when selling a home?

If the home was sold after May 7, 1997, and is the seller’s principal residence: as a single person, the seller gets up to $250,000 of gain, tax free; as a married couple, the sellers get up to $500,000 of gain, tax free.

2. If a seller makes more than the tax-free portion, can the difference be “rolled over” as in the past to avoid paying tax on it until age 55?

No, there is no more rollover privilege, but the seller doesn’t have to wait until age 55 to take advantage of the new benefits, either.

Here’s an example of what happens: Let’s assume that the sellers are a married couple (filing jointly) and their net gain is $560,000. They get the first $500,000 tax free regardless of their age; then they will pay 20 percent tax ($12,000) on the balance of $60,000. This is a huge difference over what would have happened before the tax bill. Under the old tax laws, taxes on the gain would have been deferred as long as they bought a house of equal or more value, and then only $125,000 would have been tax free after reaching age 55. The excess gain would have been taxed at a 28%.

3. How long does a seller have to live in a home before being able to take advantage of the new tax laws?

The home has to have been the seller’s principal residence for two of the prior five years.

4. If a seller is over 55 and recently took advantage of the old tax law, can’t the seller take advantage of the new law, too?

Yes, as long as the residence the seller is now going to sell has been the seller’s principal residence for two of the prior five years.

5. Does this two-year rule mean that a seller could take advantage of the $250,000 or $500,000 (depending on marital status) tax exclusion benefit every two years?

Yes, as long as it was the seller’s principal residence during the two year period.

6. What defines a “principal residence”?

Usually it is the home in which the seller lives. If a seller has more than one home, it is the one in which the seller lives most of the time. The IRS will also consider where the seller works, is registered to vote and normally receives mail. If this is a concern, a seller should seek professional advice.

7. The new tax law supposedly gets even better for sellers after 2005; how does it change?

Unless there is a revision before 2005, sellers who bought their home after the year 2005 and have lived in it as their principal residence for five or more years get to reduce the taxable portion of gain from 20% to 10%.

8. What if a seller lost rather than made money on a sale?

Unfortunately, there is no change from the old law. There is no tax benefit to offset losses on the sale of a principal residence.

9. Is it true that buyers can use their IRA funds to buy a house and not suffer the penalties of early withdrawal?

Effective in 1998-2005, buyers have this right if they use the money for the down payment on their first home. As a matter of fact, their parents or grandparents can also defer the penalties if they are withdrawing IRA funds to give it to a child or grandchild for the purchase of a first home. Remember, however, that only the penalties are waived, not the income taxes on the withdrawn funds.

I hope this overview of the new capital gains tax law is helpful to you. You should seek the assistance of a professional accountant or tax specialist before making any decisions which could impact how much tax you will owe as a result of a sale or purchase.