If We Sell Our Old House, Is the Profit Tax-Free? Miami Herald-July 10, 2006
This entry was posted on 7/10/2006 12:25 PM and is filed under Questions.
By Martin E. Segal
Q: We bought our Miami house years ago when prices were low. We raised our family there. When the children went away to collage three years ago, we rented it out to tenants for two years and moved to our vacation home in North Carolina, moved back into the house for one year, and have since rented it again. Now that real estate prices are so high, we're thinking about selling the house if we don't have to pay taxes on our gain of almost $400,000. But we've gotten conflicting tax advice about it. Can we save all or part of that profit? ---Empty Nesters
A: You'll be pleased to know that IRS guidelines for tax treatment of capital gains for the sale of one's primary residence changed dramatically in your favor back in May 1977 when Congress passed The Taxpayer Relief Act and new IRC Section 121. Under the old IRS Section 1034 there were only two loophols: tax deferral of gains as long as the homeowner bought a more expensive replacement residence within two years, and a once-in-a-lifetime tax exclusion of $125,000 of the gain if at least one seller was 55 or older.
Under the 1977 law, its temporary 2002 regulations and new rules that were effective in August 2004, up to $250,000 of profit from the sale of a taxpayer's primary residence ($500,000 per married couple filing jointly) is excluded from taxation if the property was used as the seller(s) primary residence for any two of the last five years.
If the joint owners of the residence are not married, each one is entitled to receive up to the maximum $250,000 tax-free gain exclusion. If the residence requirement is not met, gain exclusion is not entirely lost but instead may be pro-rated if moving out of the residence was due to doctor-prescribed health needs, change in place of employment of at least 50 miles, or other specified unforeseen circumstances. The computation is made by dividing the allowable gain by the number of days of primary residence use less than the full two years. (Note: Military and foreign service personnel are allowed an extended exclusion period of any two of the last 10 years.)
The gain exclusion also applies to the sale of vacant land used as part of the residence if it occurs within two years before or after the sale of the residence. This gain exclusion is not a one-time benefit like the old law, but may be claimed repeatedly as long as a sale of the principal residence does not occur more than once every two years. In addition, if there is both personal and business use in the same residence, depreciation tax deductions taken by the taxpayer must be recaptured as taxable gain. But additional gain is tax-free up to the legal limit.
Based on the facts in your question, you appear to satisfy the requirements of the 1977 law and its guidelines and would be entitled to the full tax-free gain exclusion if you sold the house. Any profit above the allowable exclusion is fully taxable at either ordinary income or capital gain rates, depending on your time of ownership....
