With the recent appreciation in real estate values, many of us have significant gains in our personal residences and other properties. Fortunately, our tax laws provide special tax breaks for gains in real estate, especially compared with other types of assets.
The biggest break comes when we sell our homes. Some of you will remember the old rules about rolling over the gain from the sale of one house into another house of greater value within two years and the one-time exclusion available to people age 55 and older. Please forget these rules. They are obsolete.
Under current law, if you sell a principal residence that you have held for two years, you are able to exclude up to $500,000 of gain if you are married ($250,000 if you are single). You can do this every two years for your whole life. You do not need to roll over any gain into the purchase of a replacement home, and the exclusion of gain is available to anyone of any age. If you have held the property for less than two years, your gains will be taxable.
The new law means that most people will be able to avoid paying tax on the gains in their home. However, there are still some circumstances that will require special planning. If you fall into one of these scenarios, we suggest a visit with your friendly tax advisor (after April 15, please).
A couple, contemplating marriage, both own a principal residence in their own name. Once a couple is married, if either spouse sells their principal residence and excludes gain, then the couple is not permitted to exclude gain on the sale of another home for two years. Be careful here; this takes some careful planning.
A person who owns multiple homes. It is now possible to convert a rental property or second home back into a principal residence (by living in it for two years) and then sell it and exclude almost all of the gain. (You�ll have to pay some taxes on the depreciation you�ve claimed since 1997.)
A retiree who purchases a second home with the intention of retiring there. Many pre-retirees will find themselves in a large home, wishing to downsize someday. If the couple purchases a second home now with the idea that they may someday retire there, they could end up losing the ability to avoid gains on their current residence. Properly planning the timing of the sale can avoid this problem. As long as the person has lived in the home for any two of the last five years prior to the sale, they can avoid the taxes.
A person who has owned their home for less than two years. If you sell your home before meeting the two-year ownership test, you may still be eligible for a partial exclusion if the move was due to job relocation, health reasons, or other �unforeseen� circumstances. You may also be able to offset gains with capital losses on your investments.
The new rules are not very complicated, but they have some tricky spots. When you are planning something as important as the sale of your home, especially if it has appreciated dramatically in value, you should at least make sure you�ve considered the tax consequences.
Tax breaks are also available on real estate other than your primary residence. Techniques such as installment sales, like-kind exchanges, and charitable remainder trusts can help you defer or avoid taxes on your business or investment properties. We will discuss such techniques in the next issue of our newsletter.