The
tax-free sale of your residence provides
a major tax break under federal tax laws.
By
Harris Ominsky and Michael R. Harris
Good
news, Federal tax law permits married taxpayers to avoid taxes
on up to $500,000 in gain.
Qualifications
To qualify for the exemption the residence must have been owned and occupied
as a primary residence for a total of at least two of the previous five years.
However, the two-year period does not have to be continuous, and the residence
qualifies if either spouse meets the two-year ownership requirement. The two-year
use requirement, however, must normally be met by both spouses.
If they fall short of these two-year requirements, the Code provides an adjustment
on the amount of the exemption based on the ratio that the actual ownership
or use bears to two years.
Under the Internal Revenue Code the $500,000 exemption applies only if the
sale is by a husband and wife who file a joint return for the year of sale.
Otherwise, the exemption for an individual is limited to $250,000.
Under federal law “profit” is computed in the way that you might
expect. It is the difference between the “adjusted sale price” and “cost
basis.” You take the sale price and subtract selling expenses such as
broker commissions. From that result, you subtract the original price paid
as well as the costs of capital improvements, such as additions and remodeling
costs.
Details
The federal law provides the taxpayer with certain breaks under extenuating
circumstances. For example, a person who has lived in a home for at least one
of the five years and has become incapacitated can count time in a nursing
home or other facility towards the two years.
Also, a surviving spouse can claim the $500,000 exemption, rather than the
$250,000 applicable to unmarried people, so long as the spouse sells the home
in the year of the death and files a joint return with the decedent that year.
In addition, the basis used to figure the profit on the portion of the property
included in the decedent’s estate is the value of that portion of the
home when the spouse died, rather than the normal tax basis.
This partially
stepped-up basis (if the residence was owned in joint names
of the spouses) could reduce any gain that has to be recognized,
and accordingly any tax due when the spouse sells the home,
since the more recent value is likely to be higher.
A surviving spouse who is planning to sell a home may find that he or she is
better off selling quickly, even if it means taking a lower price, because
there is less taxable gain to be recognized. If it is not sold in the year
of death, the exemption available to the surviving spouse will be limited to
$250,000, unless the surviving spouse remarries before the residence is sold.
A quick sale is of little advantage if the stepped-up basis is high enough
to reduce profit over the new basis to below $250,000.
Until these exemptions were adopted in 1997, homeowners could avoid taxes on
profits from selling their primary residence only by purchasing another home
within two years of selling the old one, and the new property had to cost more
than what they received for the old one. This would tend to drive a homeowner
to buy a more expensive home after selling.
In many cases, that led people to spend more then they wanted to. It would
often influence them to put all of the profit from one home into the next one,
even though they would have preferred to downsize (and price) and spend it
or invest it in another way.
New Rule Benefits
Under these new rules, owners are not compelled to spend the profits on a new
home and they can be pocketed tax-free and used to invest in the stock market,
furnish a retirement apartment, or splurge on long-postponed trips around the
world.
Some enterprising homeowners have even learned to take advantage of what might
be called serial exemptions. They build a new home from time to time, or buy
a home and renovate and improve it. If they have guessed right, they can sell
at a profit and shelter their gain under the residential exemption.
They can then take their cash and do it all over again. All they have to do
to claim these exemptions is to make sure they comply with the two-year ownership
and occupancy requirement and to wait out the two-year waiting period between
sales.
The treatment of gain on the sale of a residence for state income tax purposes
varies from state to state, and must be considered in reviewing any proposed
sale.
Harris
Ominsky is a member of the Real Estate Department in the
Philadelphia office of the law firm of Blank Rome Comisky & McCauley
LLP. He is the author of a new book, “Real Estate
Practice: Breaking New Ground”, recently published
by the Pennsylvania Bar Institute. Michael Harris is a
member of the Tax & Fiduciary Department in the Boca
Raton and Philadelphia offices of the firm. The firm has
offices in Pennsylvania, New York, New Jersey, Delaware,
District of Columbia, Maryland, Florida, and Ohio.
