The new exclusion rules improve taxpayer benefits.
From The Tax Adviser:
New Rules Affecting Home Sales and Purchases
T wo of the best-known (and probably most often used) tax breaks available to individuals in the Internal Revenue Code were the one-time exclusion of gain from the sale of a principal residence for taxpayers age 55 and over and the deferral of gain from the sale of one home when another, more costly home was purchased. With the enactment of the Taxpayer Relief Act of 1997, those provisions were replaced by a new scheme that generally allows taxpayers to exclude their gains from the sale of a principal residence, assuming they meet ownership and use requirements.
For sales (or exchanges) after May 6, 1997, single taxpayers can exclude up to $250,000 of gain on the sale of a principal residence; for married taxpayers filing jointly, the exclusion is $500,000. Any gain in excess of these amounts is taxable.
Under the new rules, taxpayers neednt invest in more expensive homes to avoid taxation on the gain; they can now move to lower cost areas (if they so desire) without having a major tax liability, or keep more of the proceeds from their home sales.
Ownership and occupancy. To be eligible, a taxpayer must have owned and occupied a home as his or her principal residence for periods totaling at least two of the previous five years. If two taxpayers are married filing jointly, they must both meet the use requirement, but only one need meet the ownership requirement. (If only one spouse meets the use requirement, the $250,000 exclusion for a single taxpayer is still available to that spouse.) And neither may be ineligible by reason of a sale of a residence within the previous two years.
If a taxpayer acquired a residence in a rollover transaction using the old rules, he or she may use the periods of ownership and use of the prior residence when determining ownership and use of the current residence.
Partial exclusion. For taxpayers who do not meet the ownership or occupancy requirements, a partial exclusion is available if the sale or exchange is due to a change in place of employment or health or unforeseen circumstances. In that case, the amount of the exclusion is equal to the general exclusion amount, multiplied by the number of qualifying months (that is, the aggregate number of months during which the ownership and use requirements were met) divided by 24.
There is no limit to the number of times this new exclusion can be used; basically, taxpayers can purchase a new home and exclude the gain every two years. In addition, it does not matter whether a taxpayer used the old exclusion rules; even if a taxpayer had taken advantage of the $125,000 exclusion under the old law, he or she is eligible to use these new provisions.
Divorced and widowed taxpayers. The exclusion is available to divorced taxpayers as well. If a principal residence is transferred to a taxpayer as a result of a divorce, the time during which the taxpayers spouse (or former spouse) owned the residence is added to the taxpayers period of ownership. The period during which the transferor spouse (or former spouse) used the property is not included; therefore, the transferee spouse still has to satisfy the use requirement. If one spouse owns a principal residence and the other spouse (or former spouse) is using it under a divorce or separation instrument, the owner will be considered to be using the residence.
Note: If divorced spouses both remain listed as owners and they agree to split the proceeds when the home is sold, the spouse who has moved out may not qualify; because he or she did not live in the residence for the previous two years, his or her share of the gain may not be eligible for the exclusion.
For widowed taxpayers, the surviving spouse is deemed to have owned and used the principal residence for the time the deceased spouse owned and used it.
Taxpayers who sold (or had a binding contract to sell) their homes after May 6, 1997, and before August 6, 1997, have a unique opportunity; they may choose between the old rollover method or the new exclusion. Taxpayers in this situation should calculate their gain under both sets of rules and determine which is more beneficial.
For a discussion of these new rules (and other developments), see the Tax Clinic, edited by Michael Koppel, in the December 1997 issue of The Tax Adviser.
Nicholas Fiore, editor
The Tax Adviser