If you sold your home last year you may owe capital gains taxes if you didn't meet certain criteria. The basics of exempting home sale capital gain from taxes is two fold:

1. You owned the house for at least two years, and

2. You lived in the home as your principal residence for two years out of the last five.

If a home seller doesn't meet this ownership and use criteria, then he or she may owe taxes. Frankly, the floor of the gain when taxes begin is so high that most homeowners will never owe capital gains taxes if they meet the two above exemptions. When you consider that the average home sale in 2003 was about $170,000 across the country, then that means most gain from houses sold in the U.S. will never be taxed. For single home sellers, the gain exclusion is $250,000 and for married tax payers, it's $500,000.

However, you could owe taxes on less than that amount of gain if you don't meet the two-year exclusion test stated above. Thus, if you bought a house in 2002 and sold it in 2003, you may owe capital gains taxes. The issue of how much you could owe, depending on when you sold the property and for what price, is a book in and of itself. Especially when you consider that the capital gains tax rates changed last year with the new rates going into effect May 6, 2003 (any taxes on gains realized before that date are based on the older, higher rates).

This column is going to deal with the exemption rules above and how you may be able to bend them or waive them altogether.

The IRS is not heartless and for some homeowners who had to sell a house in less than two years, it may be possible to claim an exclusion but at a reduced amount, if certain criteria are met. This should answer the question from many of my readers who just can't believe that they might owe taxes on the sale of their home that they lived in for just a year. Well -- you might not owe those pesky taxes, if any of the following reasons are true.

If you did not meet the ownership and use tests, but the primary reason you sold the home was:

• A change in place of employment;

• Health; or

• Unforeseen circumstances.

You may be able to avoid taxes, but you'll not get the full exclusion of $250,000/$500,000. The reduced exclusion is based on a calculation that you can find in IRS Publication 523, which takes into account how long you lived in the house and how long you owned the property to come up with a reduced exclusion amount. So instead of $250,000, it might allow you to exclude $100,000, for instance.

For those wanting a reduced exclusion because of change of employment, you'll need to at least substantiate that:

1. The change occurred during the period you owned and used the property as your main home, and

2. The new place of employment is at least 50 miles farther from your home than the former place of employment was.

The IRS will accept your call for a reduced exclusion for health reasons "if your primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual," according to Publication 523. Now a qualified individual doesn't have to be the head of household or spouse, it could also include any of the family members listed below:

• Parent, grandparent, stepmother, stepfather;

• Child, grandchild, stepchild, adopted child;

• Brother, sister, stepbrother, stepsister, half brother, half sister;

• Mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law, or daughter-in-law;

• Uncle, aunt, nephew, or niece.

However, the health card cannot be used if the sale of the house merely benefits a qualified individual's general health or well-being.

Unforeseen circumstances include a variety of events, but the IRS stipulates which ones can be used to claim this reason for requesting a reduced exclusion. First of all, if any of the following events involves the above list of relatives, then the unforeseen circumstances rationale may be used:

• Death;

• Unemployment (if the individual is eligible for unemployment compensation);

• A change in employment or self-employment status that results in your inability to pay reasonable basic living expenses (a list of these expenses can be found in Publication 523);

• Divorce or legal separation; or

• Multiple births resulting from the same pregnancy.

Unforeseen circumstances also include the following:

• An involuntary conversion of your home;

• Natural or man-made disasters or acts of war or terrorism resulting in a casualty to your home, whether or not your loss is deductible; or

• An event the Commissioner of IRS determines to be an unforeseen circumstance. For example, 9/11 was one such unforeseen circumstance for many taxpayers.

If you must sell your house before meeting the use and ownership tests, it would pay to conduct some research to find out if you can at least receive a reduced capital gain exclusion. For more information, start with www.IRS.gov. Other online resources include:

• The Motley Fool (www.fool.com), click Taxes

• Money Magazine's www.money.com, click Your Money -- Taxes

• Yahoo!'s Finance Section (http://finance.yahoo.com)

Published: March 26, 2004

Use of this article without permission is a violation of federal copyright laws.

Mr. Carr has covered real estate since 1989. He is the author of Real Estate Investing Made Simple. Got a personal real estate issue? Post your questions and comments at Anthony’s blog: commonsenserealestate.blogspot.com.