If you are selling real estate that has a capital gain, you will be exposed to capital gains taxes. Gain is a combination of the following four variables
If the property was a rental property as well as a principal residence, how much depreciation did you claim while it was a rental property? The depreciation you claimed is subject to recapture at time of sale.
Did you defer capital gains taxes from a prior sale by rolling the gain over into this property when you purchased it?
The Tax Relief Act of 1997 instituted completely different tax provisions applicable to the sale of a principal residence under Section 121 of the Internal Revenue Code (IRC). The current law, sometimes referred to as “the 121 exclusion,” has been around for about ten years. However, considerable confusion continues to exist based upon the questions we’re periodically asked.
NOTE: The Stott Team is not licensed to provide legal or tax advice. Licensed professionals like attorneys or CPA’s should be contacted for such assistance.
A taxpayer can sell real estate held and used as his or her principal residence and exclude up to $250,000 in capital gains taxes if the taxpayer is single and up to $500,000 if the taxpayer is married and filing a joint income tax return. The taxpayer has to have lived in the property as their principal residence for at least 24 months out of the last 60 months. The 24 months do not need to be consecutive. There are exceptions to the 24 months when a change of employment, poor health or other unforeseen circumstances have occurred.
For a married couple, only one spouse’s name needs to be on title; however, each spouse has to meet the 24-month occupancy test to qualify for an exclusion of up to $250,000 per spouse. And, they must file a joint income tax return in the year of sale. If two individuals are not married but both hold title and each meets the occupancy test, then each co-owner can qualify for the $250,000 exclusion. If you are in the military or Foreign Service, special rules apply and your 24-month home occupancy may be as far back as 10 years from the date of the sale.
In most cases, a taxpayer does not need to have owned the property for more than 24 months if it has been their primary residence for the entire 24 months, as the taxpayer then qualifies for 24 out of the last 60 months. However, if a taxpayer originally acquired the property via an Internal Revenue Code (IRC) Section 1031 exchange, they must have owned it for at least 60 months to qualify for the $250,000/$500.000 exclusion. They need to have rented the property for at least a year so it qualifies as investment real estate for the tax deferred IRC 1031 exchange. And, then they need to have occupied it as their principal residence for at least 24 of those 60 months.
NOTE: A sizable number of absentee owners have used the equity in their Oahu property to purchase a future residence on the Mainland via an IRC Section 1031 exchange and avoid having to pay capital gains taxes. Email us or call us toll-free at 1-800-922-6811 if you would like to discuss what is involved.
A property does not need to be a taxpayer’s principal residence on the date of sale. If it has been occupied for 24 of the 60 months before the sale, it could have been a rental for up to 36 months. Home sellers of any age can qualify. There is no need to buy a replacement principal residence (as there was with the old rule). And, the 121 exclusion can be used over and over again without limit but not more frequently than once every 24 months.
There is a little known, special provision for legally separated or divorced spouses. The purpose of this provision is to enable one spouse to be able to stay in the home for a period of time following a legal separation or divorce rather than having to sell the home for tax purposes, an example might be to postpone selling until the youngest child has finished high school. If one legally separated or divorced spouse qualifies for the 121 exclusion by occupying the home as their principal residence for at least 24 out of the last 60 months, the other spouse can also qualify for the 121 exclusion when the home is sold even though the other spouse does not meet the occupancy requirement i.e., both separated or divorced spouses can qualify to exclude up to $250,000 of gain when the home is eventually sold.
If you don’t meet the 24-month occupancy test within the last 60 months prior to the sale, you may still qualify for a partial capital gains exclusion if your move was for (1) job purposes; (2) health reasons; (3) divorce or legal separation; (4) death in the immediate family; (5) unemployment; (6) decreased income leaving the taxpayer unable to pay the monthly mortgage or basic living expenses; (7) multiple births from the same pregnancy; (8) damage to the home from natural or man-made disaster or terrorism; and (9), condemnation, seizure or other involuntary conversion of the property.
NOTE: If you owned and occupied your principal residence for only 14 months before you moved for job purposes, you would be entitled to exclude capital gains taxes of up to 14/24 or 58.33% of $250,000/$500,00.
The new Mortgage Relief bill just signed into law in December 2008 allows a taxpayer a two-year window from date of death of a spouse to claim an exclusion of up to $500,000 vice $250,000.
Commencing January 1, 2009 owners that convert a rental property or second home into a principal residence and then later sell via a 121 exclusion will need to multiply their gain by a fraction to determine the taxable portion of their gain as well as the amount eligible for exclusion. The numerator of the fraction will be the number of days from January 1, 2009 that the property is used as a rental property or second home. The denominator of the fraction will be the number of days of ownership dating from the original acquisition date. If this applies to you, you should read the next article titled “Selling a Home that was a Former Rental Property.”