Tax Payer Relief Act 1997

Gain Exclusions for Principal Residents

• Replaces one time $125,000 exclusion for seller over 55

• No age restrictions for sellers

• Sellers must have used the home as a principal residence for at least two of the last five years

• Gains excluded are $250,000 for single filers and $500,000 for joint filers

• Exclusion can be used once every two years

• Exclusion does not apply to vacation or second home properties

Observation: The new law does not specify whether the ratio should be computed using days or months.

Illustration: Susan sells her principal residence because she has a new job in another city. On the date of the sale, she has used and owned her principal residence for the last 18 months. Susan has never excluded gain from another home sale. If she had used her principal residence for two years, the entire amount of the gain ($250,000) would be excluded. Since Susan fails to meet the use and ownership requirements for the exclusion because of a change in employment, the amount of gain excluded by Susan can’t exceed the amount determined under the following ratio (computed using months, see observation above: x/250,000=18 months/24 months. As a result, Susan may exclude $187,500 of her gain on the sale of her principal residence.

Note, however, that for sales during the 2-year period beginning on the law’s enactment date, and if the taxpayer (1) held the home on the enactment date, and (2) fails to meet the 2-out-of-5 year ownership and use rule, then the partial exclusion provision applies even if the home is not sold due to change of employment, health, or other unforeseen circumstances (i.e., even if the home is sold for any reason).

Other important aspects of the new exclusion are as follows:

The exclusion does not apply to gain attributable to post-May 6,1997 depreciation claimed for rental or business use of the residence.

An unmarried individual whose spouse was deceased on the home sale date can “tack on” the decedents ownership period to her own ownership period.

An individual who receives a home in Code Sec. 1041 (a) transaction (tax-free transfers of property to a spouse, or to a former spouse if incident to divorce) can tack on the transferor’s holding period to her own holding period.

For purposes of the exclusion, an individual is treated as using a home as his principal residence during any period of ownership that the individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument.

For purposes of the 2-out-of-5-year ownership and use rule, taxpayers who deferred home-sale profits under the home-sale rollover provisions of former Code Sec. 1034 may “tack on” the old home’s ownership and use period to the new home’s ownership and use period.

The involuntary conversion (destruction as well as condemnation) of a residence is treated as a sale (and thus gain from the event may be eligible for the new exclusion).

A taxpayer who other wise qualifies for the home sale exclusion may elect not to use it.

The new exclusion applies to exchanges as well as sales of principal residences.

Information reporting won’t be required for sales of homes qualifying for the exclusion, if certain conditions are met.

Elective transition rules. At the taxpayer’s election, the new exclusion doesn’t apply to home sales before the enactment date. That means the electing taxpayer can apply prior law’s rollover and/or exclusion rules to a home sale before that date. In addition, at the election of the taxpayer, the new exclusion doesn’t apply to:

(1)  a home sale made after the enactment date under a binding contract on effect on that date, or

(2)  a home sale if gain would not have been recognized under prior law’s Code Sec. 1034 rollover provision because the replacement home was both on or before the enactment date (or is bought under a binding contract in effect on that date) (312)

It is recommended that you consult your CPA.

This information is designed to provide accurate and authoritative information in regard to the subject matter covered. It is given with the understanding that the author is not engaged in rendering legal service. If legal advice or other expert assistance is required, the services of a competent legal person should be sought.