HOW TO AVOID PAYING TAX ON THE SALE OF A PERSONAL RESIDENCE
by Craig E. Buck and Teri Anderson Buck, Attorneys at Law
Copyright (c)2003, Craig E. Buck and Teri Anderson Buck
All Rights Reserved. No part of this material may be reproduced, transmitted or stored in any manner, in any form or by any means without the express written permission of the author. Permission is granted to reproduce and distribute this text in its entirety and, if electronically, only if you include a link to our homepage at www.VirginiaClosings.com
ABOUT THE AUTHORS: Craig E. Buck and Teri Anderson Buck are partners in The Buck Law Firm P.C., specializing in real estate, and real estate closings with offices at:
8280 Willow Oaks Corporate Dr. Sutie 600 Fairfax, VA 22031 (571) 765-6210
1109 Heatherstone Dr. Fredericksburg, Va. 22407 (540) 785-2122
Craig E. Buck was Chairman of the Northern Virginia Association of REALTORS Standard Forms Committee and is author of The Real Estate Contracts Handbook. He was named the Affiliate of the Year by the Northern Virginia Association of REALTORS. Teri Anderson Buck received the Affiliate of the Year Award from the Prince William Association of REALTORS.
You must pay tax when you sell property for a profit. There is a real advantage if you can pay the tax years in the future. Liberal rules allow a rollover or exclusion of gain when you sell a personal residence. Different, more restrictive, rules apply to investment property.
WHY DEFERRAL IS IMPORTANT
There is an obvious advantage to postponing payment of taxes. The time value of money and inflation means a bill paid in the future does not cost as much as a bill paid today. If you retire and sell the property, you will be in a lower tax bracket. If you die, the property passes to your heirs at the market value at the time of your death. An entire lifetime of gain goes untaxed. But, watch out for the Federal Death Tax.
A less obvious, but equally compelling, advantage is the effect of leverage. Consider the sale of a property having a taxable profit of $100,000. Combined state and federal taxes of 38% would leave only $62,000 available to re-invest. If that $62,000 were a 20% down payment, you could purchase new property worth $340,000. If you had the entire $100,000 to put down, you could buy $500,000 of new property. If the property appreciates 5% a year, you earn $17,000 per year on one bought after paying taxes and $25,000 on the other.
FOR SALES AFTER MAY 6, 1997
Forget the old rules on rollover and exclusion of gain on the sale of a personal residence. After 1997, the tax law eliminates the need for extensive record keeping and substantially increases the amount of untaxed profit.
What Changed? Under the prior rules, you could roll over the profit from the sale of a personal residence so long as you bought and occupied a new residence, costing more, within two years of the sale. The gain rolled over to the next house until you failed to qualify and then could be taxed. You had to keep track sale expenses and improvements over a lifetime of homeownership because they reduced your eventual gain. At age 55, you could exclude up to $125,00 of gain on a joint return.
Under the new rules, anyone can completely exclude up to $500,000 of gain on a joint return ($250,000 if filing singly). The gain does not roll over. Since the gain does not roll over, neither do the expenses and you do not need a lifetime of records. You do not need to be 55 to take advantage of the exclusion. There are new rules and limits to watch.
What are the Limits? You must sell your personal residence after May 6, 1997. "Sell" means settle.
You must own and occupy the property as your personal residence for at least two of the five years preceding the sale. The two years do not need to be continuous so long as the total periods aggregate two years or more. You could occupy for six months each year for four years to total your two years of occupancy.
Partial Exclusions The new law recognizes a partial exclusion if you fail to meet the two year use and ownership requirement or if you must sell more than once in two years. For instance, if you only used the property as your personal residence for one year instead of two, you could exclude half the amount of gain. The partial exclusion is only available if you sold due to change in your place of employment, health or to the "extent provided in regulations, unforeseen circumstances."
Eliminated the Marriage Penalty Under the old law, if your spouse had ever used the over-55 exclusion, you couldn't use it. Under the new law, the exclusion can be used many times (subject to the use and occupancy rules). In addition, if either spouse meets the use and ownership test, both can benefit from the exclusion.
IRS Publication 523, "Tax Information on Selling Your Home" is available free from local IRS offices. To order, call 1-800-TAX-FORM (1-800-829-3676) or visit the IRS website at http://www.irs.ustreas.gov.