Last updated on November 6, 2019 at 12:28 pm
With the passage of the Taxpayer Relief Act of 1997, significant changes were made in order to provide individuals and married couples with the opportunity to claim exclusions from a tax on capital gains earned on the sale of their home.
This act represented a departure from previous regulations that often resulted in the payment of significant capital gains taxes — unless the seller purchased a more expensive house within a two year period.
But, under the 1997 act, individuals can exclude up to $250,000 of capital gains from being taxed after the sale of a home without having to upgrade. This also means that if an individual co-owns a home with another individual (and they are not married to each other), each individual could exclude up to $250,000 of capital gains from taxation.
Married couples who file a joint tax return could qualify for a home sale tax exemption up to $500,000. Additionally, if an unmarried couple purchases a home and lives in it for one and a half years and then gets married, they can apply those 18 months toward the two year “use” requirement mentioned below, which would mean they only have to live in the house as a married couple for six months in order to qualify for the exemption.
For those of you who are about to sell your home, there are two specific conditions that apply to anyone interested in taking advantage of the exemption: the “use” test and the “ownership” test.
- To qualify for the home sale capital gains tax exemption, you must have owned and lived in the house for a total of two out of the last five years before the sale took place — although the time does not have to be continuous. You could, for example, have lived in the house for one year, rented it for three years, and then moved back in for the fifth year and you would qualify. If you get married while you are living in the house together, you should review the “newly married couples” bonus described above.
- Conversely, if you get divorced while living in the house, you can apply the years you were together toward the two year “use” criteria, even if only one spouse remains in the home.
- You can only qualify for the home sale exemption from capital gains tax once every two years.
There are, of course, some exceptions to these criteria.
- If you fail the “use” test (because you have not lived in the house for two out of the last five years), you might still qualify for a prorated exclusion on the capital gains if you sold your house because of a change of employment, health reasons or other unexpected and unanticipated circumstances. For example, if you lived in the house for one year and then moved due to a change in your job, you would be entitled to a $125,000 tax exemption, which is the equivalent of half of the $250,000 exemption you would receive after living there for two years.
- There is also a nursing home exemption. If you have to relocate to a nursing home, the two years out of five year “use” requirement is reduced to one year out of five — and the time spent in the nursing home is applied toward fulfilling the “use” test just as if it were spent in the original home.
- You may also be eligible for special consideration if you or your spouse is on qualified official extended duty in the uniformed services, the foreign service or the intelligence community serving at a duty station that is at least 50 miles from your main home or you are residing under government orders in government housing.
- Be aware, though, that there is also a home office exception. If you have been claiming depreciation deductions for a home office, the amount you have claimed will be deducted from the capital gains exclusion. So, if you have claimed $25,000 in depreciation deductions, your capital gains exemption will be reduced by that amount, resulting in you only being able to exclude $225,000, instead of $250,000.
As you can see, the Tax Payer Relief Act is good. It eases the home-sale tax burden that had plagued home owners/tax payers for many years. In summary, you can realize up to $250,000 in profit as an individual and up to $500,000 in profit for a married couple when you are selling your primary residence! Be sure to consult with your professional tax advisor regarding how this impacts your specific situation.
Ken Bagner is a member of Sobel & Co. LLC. He is a member of the American Institute of Certified Public Accountants and the New Jersey Society of Certified Public Accountants. Plymouth Rock Assurance is proud to partner with NJSCPA to bring you valuable tips for about your financial health. Qualified members of the NJSCPA can receive a discount on their car insurance through Plymouth Rock Assurance New Jersey.