New Rules on $250,000-$500,000 Capital Gain Exclusion on Sale of Principal Residence

December 1, 2008 · 4 Comments 

Filed Under Property Taxes

The 11-2-2008 SF Chronicle real estate section has some good information on Capital Gains Tax and the Principal residence exemption as applies to the new regulations.

How to calculate the Cost basis?

Two Year ownership requirement?

Time limits – Holding period for the house to qualify for the exemption?

Do Vacation Homes qualify?

Q: Can you please define “capital gain”? You mentioned the term in one of your previous articles, but I did not quite understand how it would benefit me. My husband passed away five years ago and I am ready to sell our home and downsize to a smaller one. The house is 30 years old and the mortgage was paid off two years ago. I would appreciate any information you could give me on the subject.

A: Capital gain is the profit you have made on your house. You take your original purchase price, add to it the cost of any improvements you may have made, and you add certain expenses that you paid when you first went to closing. These expenses can be found in IRS Publication 523, Selling Your Home. This is called the “tax basis” of your house.

Then you take the selling price of your house and deduct any real estate commission you may have paid, as well as other expenses such as advertising, legal fees associated solely with the selling of the house, and any loan charges you may have paid for your buyer. This is the adjusted selling cost. To get your gain you subtract your tax basis from the adjusted selling cost.

This is a very oversimplified explanation. I have not discussed your situation about where your husband died because you will get a stepped-up basis that will differ depending on where you live.
Furthermore, I have not discussed the up-to-$500,000 exclusion of gain (up to $250,000 in your case because you cannot file a joint tax return) that you can take if you have owned and used the house for two out of the five years prior to its sale.

You should carefully review the IRS publication, and if you still have specific questions, talk with your own tax and legal advisers.

Q: I want to buy my brother’s home (essentially for the amount of the mortgage), which I would allow my brother to continue to live in, and which I would use as a second (vacation) home. When my brother leaves the house (death, nursing home, etc.), I plan to sell the house and use the IRS $250,000 capital gain exclusion (assuming at least two years of ownership). Are there any potential problems with this plan? Would it be wise to place the house in a trust?

A: You have to talk with your attorney as to whether to put the house in trust. There are many variables, which are individual and possibly unique to your situation, so I don’t believe it would be appropriate to give you advice on this issue.

I see no real problems with your proposed plan. However, you should know that the new Housing and Economic Recovery Act of 2008, signed into law by President Bush on July 30, 2008, puts some restrictions on your ability to claim the full $250,000 exclusion of gain.

This is complicated, but suffice it to say, if you sell a second home (whether it be a rental property, a vacation home or the type you are describing) the exclusion will be allocated between the time you owned the property and the time that you actually lived in it. In simple terms, the period of time you used the property as your principal residence will be eligible for the gain exclusion; the time that it was not your principal residence may be taxed.

Q: My wife and I are considering renting our current primary residence for a short time after we build a new house with the idea of letting the housing market stabilize before we sell our current home. What are the tax rules regarding renting a primary residence and still counting it as a primary residence when sold?

A: In order to be eligible for the up-to-$500,000 exclusion of gain ($250,000 if you are single or do not file a joint tax return), you have to own and use (live in) the property for two out of the previous five years before the house is sold. In your example, if you already have owned and lived in the house for at least two years, you can rent it out for one day less than three more years.

Be careful, however. If you rent out your house, will potential buyers be interested in buying when there are tenants? Will you be able to get the tenants out of the property in time to sell before the three years are up? Perhaps an investor can be found to buy and let the tenants stay in the house, but you cannot count on finding such a buyer.

If you decide to rent, my suggestion is to make sure that the lease completely expires in two years. This will give you one full year in which to find a buyer. Otherwise, you will have to pay capital gains tax on any profit you make, unless you either hang on to the house as a long-term investment or do a 1031 (Starker) exchange.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

This article appeared on page L – 1 of the San Francisco Chronicle 11-2-2008

Related posts:

  1. IRC 1031 Tax Deferred Exchanges
  2. Property tax savings with Prop 60

Comments

4 Responses to “New Rules on $250,000-$500,000 Capital Gain Exclusion on Sale of Principal Residence”

  1. Property on December 2nd, 2008 1:05 am

    Under current law, a surviving spouse has only until the end of the tax year in which the death occurred to use the exclusion. Property

  2. Scott Cash on December 2nd, 2008 6:31 pm

    Notice they never want to discuss commercial property?
    I have been reducing assessments on commercial property in California since 1991. I have been successful on Retail centers, Office buildings, Industrial buildings, Mini Storages, bare land, apartments and special use properties.
    I work on a contingency so you cant loose. If you have any questions, please contact me. (916) 747-8510.

  3. Len on March 23rd, 2009 5:26 pm

    “Q: I want to buy my brother’s home (essentially for the amount of the mortgage), which I would allow my brother to continue to live in, and which I would use as a second (vacation) home. When my brother leaves the house (death, nursing home, etc.), I plan to sell the house and use the IRS $250,000 capital gain exclusion (assuming at least two years of ownership). Are there any potential problems with this plan? Would it be wise to place the house in a trust?”

    I disagree with the author’s comment “I see no real problems with your proposed plan…”

    The questioner is not able to use the capital gain exclusion for a house which is not his principal residence, whether it is a second home or one his brother occupies. He did not say he would move into the house as his principal residence for 2 years after his brother dies. Only if he did would he qualify for any exclusion at all.

    The author is correct however that the new rules effective 1/1/2009 provide that any gain gets reduced/prorated by the number of months of ownership after 1/1/2009 which are not principal residence. That is a new change.

  4. Tom Carlson on May 6th, 2009 4:34 pm

    Len,

    That is an interesting question and quite complicated. I would recommend consulting a CPA and a tax attorney. Their fees will be well worthwhile.

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