Still confused about capital gains tax relief?
Welcome to the club.
When the 105th U.S. Congress passed H.R. 2014, the Taxpayer Relief Act of 1997, tax preparers jokingly referred to the complex measure as the "Tax Preparers Full Employment Act."
That's because, unless you are schooled not just in tax law, but also tax law interpretation, revisions and calculus, you will need a professional tax preparer to guide you through the provisions that apply to capital gains from home sales, which make up only a fraction of the larger set of tax regulations.
Almost a decade ago, sighs of relief welcomed the windfall of capital gains tax benefits from the act, but every year at tax return time those sighs sound more like muttering and mumbling as first-time sellers face the law's intricate details.
Well in advance of tax return filing time, and so you don't procrastinate getting information about the law, here's a brief cheat sheet to give you some quick insights on what the law means to you if you sold a home this year. Tuck it away now for use later.
- First, by now you should have long ago forgotten the old $125,000 tax exclusion on capital gains for home owners older than 55 and the "rollover" law that allowed you to defer paying capital gains taxes provided you purchased another, more expensive home in time.
Those laws are history. Forget them.
- The relief act's primary provision for home sellers is the capital gains tax exclusion -- when you sell your home, if you qualify, you can keep, tax free, capital gains of up to $500,000 if you are married filing jointly or $250,000 for single taxpayers, or married taxpayers who file separately.
Your capital gain on the sale of your home is the selling price minus your cost basis. The cost basis is your purchase price, plus qualified purchase costs, improvements and selling costs, minus any accumulated depreciation, say for a home-based business. A professional can help you more specifically calculate your gain if you are not sure what qualifies and what doesn't.
- To qualify for the $500,000 or $250,000 exclusion, the home must have been your primary residence of record for at least two of the prior five years.
- If you have a second home that is also a primary residence of record, say where you live, go to work, send the kids to school or otherwise use as your primary record, say, every other year, it will take four years to quality either or both homes. While you may qualify both simultaneously, the law only allows you one exclusion every two years.
- So long as you meet the primary-residence-of-record, two-out-of-five-years requirements you can take the exclusion as often as you meet the qualifications -- for life.
- If, however, through some qualifying unforeseen event, such as a job change, illness or some other hardship, you are forced to sell before you meet the two-year residency requirement you can only prorate the $500,000 or $250,000 exclusion (not your specific gain) if you are forced to sell early. That means if you only live in your home one year -- half the required time to get the full exclusion -- and you are forced to sell for some qualifying unforeseen event, you can exclude from taxes, up to $250,000 in capital gains if you are married and file jointly or up to $125,000 for separate and single filers -- half the total exclusion allowed.
What are unforeseen circumstances?
- Multiple births resulting from the same pregnancy.
- The death of the homeowner, a spouse, co-owner or other person whose principal place of residence is the house that was sold.
- Divorce or legal separation.
- Health problems, if the primary reason for the sale is "to obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury" of the home owner, co-owner, spouse or other resident.
- A loss of employment triggering eligibility for unemployment compensation.
- A change in employment status that results in the owner's inability to pay housing costs and reasonable basic living expenses.
- The "involuntary conversion" of your home, say, when the state government or other eminent domain order requires you to sell your house to make way for a new highway.
- Military duty. Military personnel posted abroad for extended periods can stop the clock on the two-of-the-past-five-years provision until they return stateside.
There's another tax relief law break for home owners with home-based businesses.
- As long as your qualified home-based business is in the same dwelling as your primary residence -- rather than some unattached structure on your property -- you don't have to allocate a home sale's capital gains between the home and the business. Previously if you used, say, 10 percent of your home for a home-based business, 10 percent of the gain from a sale would be subject to capital gain taxes and you couldn't use the exclusion on that portion.
The provision does not excuse you from a recapture tax if you've taken a depreciation deduction because of the home-based business.
For these and other tax law provisions, professional help is key to an accurate tax return.