The Tax Byte

Planning for the Tax-Free
Sale of Your Home

New Tax Law Benefits Both Investors and Sellers of Personal Residences!!

New $500,000 Exclusion for Home Sales

You have to love the new tax bill, especially the part that allows you to exclude gain of:

$500,000 for married taxpayers
$250,000 for single taxpayers

To exclude the gain, you must use the home as your principal residence for 2 of the last 5 years. Moreover, you can use the exclusion once every 2 years for the rest of your life. Further, age is not an issue. You can be age 20, 40, or 60 when you claim your exclusion. The new law eliminates the old $125,000 exclusion for a taxpayer age 55 and over and replaces it with the new, any age, bigger bucks exclusion.

The new rules apply to homes sold after May 6, 1997. They replace the rollover and one-time exclusion rules. Should you so desire, you may elect to apply the old rules to a home sale made.

After May 6, 1997, and before August 5, 1997
After August 5, 1997, pursuant to a binding contract in effect on August 5, 1997
Where the replacement home was acquired or under contract on or before August 5, 1997, and the rollover provision would apply.

Partial use of the $500,000: Should unforeseen circumstances such as health, job change, etc., cause you to move before you occupy the home for 2 years, you may exclude the fractional part of the 24 months you occupy the home as your principal residence. Thus, if you lived in the home for 12 months before employment forced you to move, you could use up to 50 percent of the exclusion.

Fewer tainted spouses: Unlike the old law where marriage to a person who had used the $125,000 exclusion caused you to lose the $125,000, the new law removes the "tainted spouse" problem. If a single taxpayer eligible for the exclusion marries a taxpayer not currently eligible for the new exclusion due to recent use, the new law allows the newly married taxpayer his or full maximum "single person" exclusion of $250,000. Further, once both spouses pass the 2-year test, they may exclude up to $500,000 of gain on their joint return.

Fairer divorces: The new law treats divorces more fairly. The home used by the former spouse pursuant to a divorce instrument counts as home use by the individual for purposes of the exclusions.

The exclusion does not include any gain attribution to depreciation deductions claimed after May 6, 1997. Thus, the new law taxes gain attributable to depreciation after May 6, 1997. Gain from depreciation before May 7, 1997, escapes taxation to the extent of either the $500,000 or $250,000, whichever applies.

Strategy 1: Buy, remodel, and sell an appreciated home every 2 years.

Strategy 2: Make your vacation home your primary residence for 2 years and then sell it.

Strategy 3: Make your rental property your primary residence for 2 years and then sell it.

Strategy 4: Get divorced -- if you were planning on a divorce but held off because of the home sale rules your problem is solved.

Strategy 5: Make your yacht or houseboat your primary residence for 2 years and then sell it.

New Capital Gains Rates Build Net Worth: Increase Rates of Return

The new law favors appreciating real estate, stocks, and similar assets. It does nothing for collectibles. For qualifying assets held more than 18 months, the new law taxes capital gain "attributable to appreciation" above cost (or other original basis) at:

20 percent (down from 28 percent), or
10 percent (down from 15 percent) for those earning less than $41,200

The "old" percent maximum capital gain rate continues to apply to:

Collectibles like gold, silver, coins, antiques, artwork, etc.
Assets held more than 1 year but not more than 18 months

The new 20-percent maximum rate does not apply to gain from depreciation. Instead, the new law places a 25-percent maximum rate for capital gain "attributable to depreciation."

Example: You sell a real estate rental for $400,000. You paid $220,000 for the property originally and you claimed $60,000 of straight-line depreciation since purchase. You pay tax on sale as follows:

20 percent on $180,000 of appreciated gain ($400,000 minus $220,000 cost)
25 percent on $60,000 of gain attributable to depreciation

On this sale, the new law saves you $16,200 in tax. Under the old law, you would have paid tax of $67,200 based on 28 percent on your total $240,000 gain. Under the new law, you pay tax of $36,000 on the $180,000 of appreciated gain and $15,000 on the $60,000 of depreciation gain for a total tax of $51,000.

To put the advantages of the new capital gain rates in perspective for real estate, look at the breaks this way:

In the example above, the new law reduces your tax bite by 24 percent ($51,000 divided by $67,200)
The additional breaks probably add more than 10 percent to your annual after-tax return from the property. Thus, if you were making 10 percent a year after tax before the new law, you now make 11 percent a year on your investment, after tax.
The new law increases the retail value of rental properties because they now return more after-tax income.

In addition to real estate, everyone who owns stock has to love the new law. With stock, you simply apply the lower rates to the gain.

The lower capital gains rates apply to assets held more than:

18 months and sold after July 28, 1997
12 months and sold after May 6 and before July 29, 1997

For assets owned or acquired on or after January 1, 2001, and held for more than five years, the maximum capital gains rates on appreciation will drop from:

20 percent to 18 percent
10 percent to 8 percent

The 5-year holding period expires after 2006. Thus, the lowest rates do not come into play until 2006 or later.

Obviously, the new rates help your investment returns and make investments in appreciating assets more valuable. However, just like the old days, you get maximum return when you buy low and sell high.