Federal tax changes affect gain on sale of second homes
The U.S. Government did a great thing for homeowners back in 1997. The Taxpayer Relief Act allowed a homeowner to exclude up to $250,000 of gain on a residential sale. Married homeowners filing jointly could exclude up to $500,000 of gain.
Tax-free profit - that's hard to beat. Many of us were able to use the exclusion and sell a property, then upgrade to a better home. With our economy going the way it is (not so good), Congress is making some changes that will affect the home sale exclusion.
As the law is currently written, a homeowner must reside in the residence for two out of the last five years. Meeting this test allows the homeowner to take the full exclusion. The gain exclusion can be used once every two years.This means a homeowner could theoretically own two houses, living in a residence for two years then moving to the next one and selling the first for a tax-free gain. With the proceeds from the first home sale, he could buy another house, etc.
Beginning January 1, 2009 the rules will change. From that day forward, the exclusion will be limited to "Qualified Use" - that is, the time the owner resided in the home. When a home is used as a rental or vacation home, that period will be considered "Non Qualified Use" and subject to taxable gain.
Here's an example: A couple buys a home on January 1, 2009 for $500,000. They live in the home two years and rent it out for one year. The house is sold on January 1, 2012 for $1,000,000.
- Under the old law, the couple met the two out of five year requirement and their gain would be excluded from capital gains taxes.
- Under the new law, the couple would have 1/3 (one out of three years owned) of the gain taxed at capital gains tax rates. Two thirds of the gain would remain tax free.
The new law is still good for homeowners, just not as good as it used to be!
Properties purchased prior to 2009 then sold 2009 or later
The period a property was owned prior to January 1, 2009 is not subject to the allocation. In other words, it's not taxable for capital gains if the owner met the "two out of five" criteria.
Example: A couple bought a home on January 1, 2005 for $300,000. They use it as a second home and make it their primary residence on January 1, 2010. Two years later, they sell the home for $1,000,000.
The couple has met the "two out of five" criteria for gain exclusion. But for the year 2009 the house was their second (not primary) home. That one year out of eight that the couple owned the home makes the fraction for calculating their taxable gain 1/8 X $500,000 gain = $62,500 to be taxed at capital gains rates.
Summary of the tax law relating to sales of residential properties
This is a complicated issue - let's start from the beginning.
- If a single person lives in a home for two out of the last five
years and owns it for at least two years, he can exclude up to
$250,000 in gain on the sale of that residence.
- If a married couple filing a joint return meets the same
criteria (both must have lived in the home two out of the last five
years) they can exclude up to $500,000.
- If the owners live in the home (for two out of the last
five years) and then rent it out or use it as a vacation home and
sell the property by December 31, 2008, they still get the full
- If the owners live in the home (for two years out of the last five) and then rent it out or use it as a vacation home and sell the property AFTER December 31, 2008, the period after 12/31/08 (when the property is a rental or second home) until the time the property is sold is considered "Non Qualified" use and the property becomes subject to the allocation.
- The period that a property is used as a vacation home or rental up to 12/31/08 does not become a problem (does not create a taxable gain) as long as the couple has lived in the home for at least two out of the last five years.
- For those of us who own just one real estate property and use it as a principal residence, after you've owned and lived in the home for two years you can exclude your capital gain the same way as before! It only gets difficult when owners move out of their home and sell it later at a gain.
Realtors: If your seller is looking at offers and contemplating, it is important for them to know this tax law if it affects them! Understanding the rules might help us get a few more sales by the end of 2008.
Prospective sellers: Check with your tax attorney or CPA. Other factors not discussed in this article may affect your decision and the amount of taxable gain on your transaction.