|
Scott & Huff, P.C. 1000 S. Garfield Ave. Suite 3 Traverse City, MI 49686 (231) 933-5322 |
||||||||||||
|
New
Limit On The Exclusion of Gain From Sale Of Home By Diane Kuhn Huff Taxpayers
are permitted to exclude all or a portion of capital gain realized on
the sale of a principal residence under certain conditions.
Most notably, the taxpayer must have owned or used the property
as his or her principal residence for an aggregate for two of the
preceding five years. The
taxpayer could then exclude capital gain in the amount of $250,000 or,
if married and filing a joint return, $500,000. These rules are codified in Section 121 of the Internal
Revenue Code (IRC 121).
Beginning
January 1, 2009, not all of the gain may be excluded.
The Housing and Economic Recovery Act of 2008 amended IRC 121 to
limit the exclusion on the sale of a personal residence. The new amendment added a new subsection (b)(4), which does
not allow the exclusion of gain that is allocated to periods of
nonqualified use. Nonqualified
use means any period after January 1, 2009, during which the property is
not used as the principal residence of the taxpayer or the taxpayer’s
spouse. On the other hand, nonqualified use does not include the five
year period after the property is used as the taxpayers principal
residence. So
what does this mean? The primary impact of the change is that taxpayers who own
second homes may not be able to exclude the maximum $250,000 of gain unless
the taxpayer makes that residence his or her principal residence on
January 1, 2009 or immediately upon purchase.
This exclusion is most likely to affect taxpayers who choose to
make renovations before making a residence their principal residence
and, taxpayers who make their second home their principal residence in
anticipation of later selling the property and excluding the gain.
The
following examples show how this works:
Example
1:
Alan and Betty are married and file a joint tax return.
On January 1, 2009, they buy a second home. On January 1, 2013, they move into that home and make it
their principal residence. On
January 1, 2019, they sell the home, realizing a gain of $500,000.
Because during 4 of the 10 years of ownership Alan and Betty did
not use the property as their principal residence, they cannot exclude
four-tenths of the gain, or $200,000, on which they will be taxed.
They can exclude $300,000 of gain. Example
2:
Ellen is single. On
January 1, 2009, she buys a second home, but does not immediately move
into it. Instead, she retains her old home and has her new home
renovated for a period of six months.
After this time, Ellen moves into the new home and makes it her
principal residence. On
July 1, 2012, she sells the property at a gain of $250,000.
She will exclude $200,000 of gain and be taxed on $50,000 of
gain. (5/6th of
gain is excluded). On
the other hand, as long as the taxpayer owns the property, immediately
makes it his principal residence and, uses it as his principal residence
within two of the next five years, the taxpayer can claim the full
exemption. The following
examples show how this works: Example
3:
Assume the same facts as in example 2 except that Ellen gives up
her old home and makes the new home her principal residence, residing
there while the renovations are accomplished.
In these circumstances, Ellen can exclude all of the gain. Example
4:
Frank and Grace are married. On
January 1, 2009, they buy a home and make it their principal residence.
On July 1, 2009, they move out of the home and rent it out for
three years. On July 1, 2012, they again use the home as their principal
residence and continue to do so until they sell the home on January 1,
2014, realizing a gain of $500,000. Because they made the home their
principal residence on purchase, and aggregated two years of use as a
principal residence during the five-year period, they will be able to
exclude all of the gain. There
seems to be a hole in the law in that as long as the taxpayer uses the
property as his principal residence first, the taxpayer can then make
any use of the property for up to three years but still reap the full
benefit of IRC 121. Therefore,
it becomes imperative for new property owners to establish immediately
the property as their principal residence to qualify for the full
exclusion of gain under IRC 121. Source:
Taxanalysts, TaxPractice December 19, 2008 |
Back
to List