Inability to Rollover:
One Tax-Law Catch
Several readers say they're selling their homes and want to know whether they owe capital-gains taxes.
Most homeowners won't owe any capital-gains taxes when they sell their primary residences. Why? Because of tax-law changes enacted in 1997. The basics of these rules may seem fairly simple. But they have inspired many questions from readers because the 1997 law includes some surprisingly tricky twists and turns.
Because of this law, you may be able to exclude as much as $250,000 of your gain if you're single, or as much as $500,000 if you're married and filing jointly. To be eligible for the full exclusion, you typically need to have owned your home and lived in it as your primary residence for at least two of the five years prior to the time you sold it.
What if you haven't owned it that long? That's the question I received recently from a friend who is selling his New York City apartment, which he has owned for only a few months, to move to Washington, D.C., for a new job. The short answer is that my friend is in luck since he is selling primarily because of a change in place of employment. That's one of the three general reasons that allow you to qualify for a reduced maximum exclusion, based on how long you owned and lived in your place. The other two reasons are "health" and "unforeseen circumstances." To figure out how much of an exclusion you can claim, see worksheet three ("Reduced Maximum Exclusion") of Publication 523, available on the IRS Web site.
Yes, I realize that wording such as "unforeseen circumstances" sounds remarkably vague and hard to define. The Treasury has tried to answer many questions with lengthy regulations, which are summarized in Publication 523.
Question: Can you still defer capital-gains taxes when you sell your home by rolling over your gains into a new home within a certain time period?
-- C.P., New Britain, Conn.
Answer: No. The "rollover" provision you're thinking of disappeared as part of sweeping tax-law changes enacted in 1997. But the 1997 law drew widespread applause because it effectively eliminated capital-gains taxes for most people who sell their primary residence. This law typically allows a capital-gains exclusion of as much as $250,000 for singles, or as much as $500,000 for a married couple filing jointly.
To qualify for the full exclusion, you must have owned your home, and lived in it as your primary residence, for at least two of the five years prior to the sale.
While this new law is great news for most sellers, it's bad news for some people who have amassed very large profits -- gains that are even larger than the exclusion. In some cases, homeowners who previously could have deferred, or even avoided, paying capital-gains taxes now have to pay a hefty tax. Not surprisingly, congressional staffers heard complaints about this from some owners who bought homes decades ago, when prices were much lower, and hung on to them. Those complaints didn't attract much sympathy in Washington. The new home-sale rules have sparked more questions than any other tax subject I've written about. Treasury officials analyzed the subject for years and finally issued lengthy regulations in an attempt to answer many thorny questions. For details, see IRS Publication 523 ("Selling Your Home"), available on the IRS Web site. For a shorter version, see chapter 16 of Publication 17.
Question: We own a summer and a winter home in the same state and are thinking of selling one of them. Which one would qualify as the primary residence and thus be eligible for the most favorable tax benefit? E.P.S., North Kingstown, R.I.
Answer: The Internal Revenue Service says your main home is "ordinarily the one you live in most of the time." But that's not the only consideration. The IRS also offers a long list of other factors that can influence the answer. Among these are where you work, your mailing address for bills and correspondence and the address shown on your federal and state tax returns, driver's license, car registration and voter registration card. Other factors that may be relevant include the location of banks you use, the location of recreational clubs and religious organizations you belong to and the principal place of abode of your family members. In short, the answer essentially boils down to what tax geeks frequently refer to as "facts and circumstances." See IRS Publication 523 ("Selling Your Home"), available on the IRS Web site ( www.irs.gov), which summarizes Treasury regulations issued late in 2002 to elaborate on a law enacted in 1997. To be eligible for the full capital-gains exclusion (of as much as $250,000 if you're single or as much as $500,000 for married couples filing jointly), you typically must have owned the home and lived in it as your primary residence for at least two of the five years prior to the date you sold it. If you can't meet this two-year test, you may still be eligible for a reduced maximum exclusion if you sold for certain special reasons, such as health, a change in your place of employment or "unforeseen circumstances." How in the world does the Treasury define "unforeseen circumstances"? See IRS Publication 523, which cites several factors, including divorce, death or multiple births resulting from the same pregnancy.
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