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.
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.
THE RULES
Under the new rules, anyone can completely exclude up to $500,000 of gain on a joint return ($250,000 if filing singly).
What are the Limits? 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.”
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.
ADDITIONAL RESOURCES
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 https://www.irs.gov.