The Internal Revenue
Service has proposed new regulations that make it easier for people who
don’t meet the standard two-year home-sale rule to save taxes on sale
profits. The regulations also provide a tax break to those who operate a
qualified home office.
In 1997, Congress
passed a law that allows homeowners to sell their principal residence
and pocket up to $500,000 in profits without paying any tax on those
gains. Generally, the law applies to taxpayers who own and live in their
home for at least two out of the five years before the sale. Qualified
single homeowners can exclude up to $250,000 in profits from
capital-gains taxes, and married couples filing jointly can exclude up
to $500,000.
People who live in
their home fewer than two years can take a reduced tax exclusion, but
only under limited circumstances. The new temporary guidelines not only
clarify those exceptions, but carve out some additional tax breaks.
The regulations cover
three major exceptions to the two-year qualification rules: a change of
employment, health reasons and the catchall “unforeseen circumstances.”
Change of employment.
You may qualify for a tax savings if you sell your home in fewer than
two years from the time of purchase if a “qualified member” of your
household—you, a spouse, a co-owner or household member—moves due to a
job change. To qualify, you must move at least 50 miles farther than the
distance your old home was from your old place of work, though you may
qualify under some circumstances even if the distance is less then 50
miles.
Health reasons. You
may qualify if you must move in order to diagnose or treat a disease,
illness or injury for a qualified person, or to receive care for that
medical problem. This provision includes cases where you move to care
for a sick relative.
Unforeseen
circumstances. This phrase wasn’t defined in the original legislation.
Unforeseen circumstances defined by the IRS now include death, divorce or
separation, pregnancy involving multiple births, the sale of your
residence because of government seizure, loss due to a man-made disaster
or act of war, and severe debt problems
How do you calculate the
reduced exclusion amount? Say you and your spouse are forced to sell your
home 18 months after you buy it due to a job change. The reduced exclusion
amount is a percentage of the maximum excluded amount based on the time
you lived in the house. In this case, you divide 18 months by 24 months
(the 2-year minimum), which is 75 percent. Thus, you can shelter up to 75
percent of the $500,000 maximum normally allowed—$375,000 in profits. Most
married couples won’t earn that much profit from a shortened sale, so they
usually will be able to shelter their entire profits.
By the way, the new
regulations also clarify that profit from the sale of vacant land attached
to the principal residence is eligible for exclusion as long as the land
is sold concurrently or within two years before or after the sale of the
residence.
The IRS threw in a bonus
for taxpayers who work out of a qualified home office. Home-office
taxpayers have long been able to take numerous deductions, ranging from a
percentage of household utilities and mortgage interest to depreciation.
The catch has been that the portion of the gain from the sale of the home
attributable to the portion of the house occupied by the home office was
subject to tax. For example, if you made a $100,000 profit, and your home
office occupied ten percent of the house, $10,000 was subject to a
capital-gains tax.
The new rules now allow
the home office portion to be sheltered along with the rest of the
residence, with one exception—there’s still a recapture tax on any
depreciation deduction taken over the years.
For more details, talk
to your tax advisor or financial planner. If you sold a home in the 1999,
2000 or 2001 tax year that had gains taxed, consider filing an amended
return.
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February 2003 — This column is produced by the Financial Planning Association, the
membership organization for the financial planning community.
