Housing Act Tightens Home Sale Exclusion

A revenue-raising provision of the Housing and Economic Recovery Act of 2008 enacted in late July (PL 110- 289) disallows exclusion of gain from the sale of a principal residence under IRC § 121 attributable to periods the dwelling is used as a vacation or rental home or other nonqualified use. Nonqualified use is any use other than as a principal residence by the taxpayer, spouse or former spouse.

Section 121 allows exclusion of up to $500,000 in gain by joint filers ($250,000 for singles) on the sale or exchange of property that has been owned and used as the taxpayer’s principal residence for at least two years out of the previous five. An exception to the new provision is allowed for periods after the home is no longer used as a principal residence by the taxpayer or taxpayer’s spouse occurring within the otherwise qualifying five-year period preceding the sale. Exceptions also are provided for certain temporary absences of up to two years and those during extended military or other specified government service. The new provision, which would curtail or contraindicate some strategies described in previous JofA articles “ Home Sweet Home,” April 06, page 77, and “Home Free,” Jan. 07, page 40, is effective for sales and periods of nonqualified use occurring after 2008.

Tax benefits introduced by the act include a temporary standard deduction for non-itemizers who pay real property taxes. Just for tax year 2008, the deduction is equal to the amount of real property tax paid, up to $1,000 for joint filers and $500 for singles. Also, a temporary first-time homebuyer credit is worth 10% of the home’s purchase price, up to $7,500 for joint filers. Although the credit is refundable, it must be repaid over 15 years, making it in essence an interest-free loan. The credit begins to phase out at adjusted gross incomes over $150,000 for joint filers and is available only for homes purchased between April 9, 2008, and June 30, 2009.