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Selling Your Home

The law now exempts up to $250,000 of the profit on the sale of your primary residence and up to $500,000 on a joint return. This is a significant improvement over the previous ‘rollover’ provision that allowed one to ‘rollover’ profits into the next transaction and then take a one-time exemption if you were over 55 years of age.

If you sold a home after May 6, 1997, the date that the new law took effect, you should look at the law’s definition of the term ‘principal residence’. By law, your home must have been used as your principal residence for two out of the five years prior to the sale. The exclusion may be used once every two years.

If you rented the home for two years but used it as a personal residence for the previous three years, you could theoretically still take advantage of the exclusion, even if you have another home. Both the courts and the IRS have not had time to further define the term ‘principal residence’. If the IRS is as liberal as the letter of the law, many taxpayers will benefit.

Selling Rental Property

If the property was held more than 18 months, the new law lowers the maximum capital gains rate to 20% for most transactions. The previous maximum rate was 28%, which was only an advantage to higher income tax payers because there was no lower rate available. For instance, if your tax bracket was 15%, you were better off taking capital gains as ordinary income.

The new maximum rate has been lowered to 20%; and 10% is the new lower rate for those in the 15% tax bracket. For those selling homes that will not be eligible for the principal residence exemption, these new rates will be a distinct improvement.

There is an exception to the 20% rule if the rental property being sold has been depreciated. The portion of the gain due to depreciation will be taxed at a higher rate, 25%. For instance, a property is purchased at $100,000 and sold at $150,000 after $15,000 of depreciation is taken. Of the total $65,000 gain, $50,000 will be taxed at 20% and $15,000 will be taxed at 25%.

First Time Homebuyer IRAs

The taxpayer is allowed under the new law to set up a ‘non-deductible’ or Roth IRA. Contributions to these IRAs are not deductible from taxes, but accumulated gains are tax-free. Funds may also be withdrawn tax-free.

One drawback of these IRAs is that tax-free withdrawals cannot occur for five years from when the contribution is made. There are exceptions to this rule and the one exception that is most important to homeowners is the exception for a qualified special purpose.

A qualified special purpose is defined by law to include up to $10,000 for the acquisition costs of a principal residence for a first time homebuyer. The buyer can be the taxpayer or an immediate family member. A similar exemption was put in place for regular IRAs.

Planning your tax strategy will allow you to take full advantage of the tax breaks now available. However, tax laws tend to be subject to many interpretations and the meanings of many of the provisions may change as case law and IRS regulations change. You are advised to check with your tax advisor before acting upon any of the new provisions.