Tax-Exemption Advice
For Large Capital Gains

Question: My wife and I are thinking of selling our house in Old Greenwich, Conn., which we've owned for nine years. We have invested approximately $750,000 in the house and are looking to sell it for $1.7 million. From what I understand, we would need to pay capital-gains taxes on profits over $500,000. My question is, can this tax be deferred by re-investing it in our next house and, if so, how much should we pay for a house to avoid the tax?

-- Tom, Old Greenwich, Conn.

Tom: You’re partly correct. Under the rules passed by Congress in the 1997 Taxpayer Relief Act, married couples can exclude up to $500,000 in gains provided they have lived in the home for two of the past five years and the home meets the requirements for a principal residence. From what you describe, that means that you probably will be able to exclude the first $500,000 of capital gain. Check with your accountant to be sure.

However, you will have to pay tax on the balance of your capital gain over $500,000. Under the old rules you could have deferred the entire amount by rolling it over into a new home. However, that rule was eliminated.

It’s interesting to note that while the up-to-$500,000 exclusion (for married couples) benefits most home sellers, it actually can hurt those who have very large capital gains.

Question: I recently filed for Chapter 7 bankruptcy protection, which was originally filed as a Chapter 13 bankruptcy and was converted to Chapter 7 in January. I also entered into foreclosure for my home, mostly due to medical and other problems. I incurred a lot of debt at this time. I have good income from my job as a consultant in systems engineering ( more than $95,000 a year) and have a long tenure at my present employer. I am now renting a luxury home in a very nice neighborhood. How long will I need to wait to qualify for a mortgage loan? My landlord has said that he might offer the home to me in an installment contract in a year or two. I am considering this option but want to know if I will have an opportunity to own again on my own and whether other options are available to me. I have started to re-establish my credit by making all of my debt payments on time. Prior to my bankruptcy, I paid all of my bills on time for 15 to 20 years.

-- Sonja, no location provided

Sonja: The bad news is that bankruptcy and foreclosure will almost certainly pop up on credit reports that any lender runs. The good news is that they should not affect you adversely forever.

It sounds like you're doing the right things in attempting to re-establish credit. Most credit advisers suggest that two years of good credit should help turn things around.

I would also suggest that when you apply for a new mortgage, you include a letter with your application explaining that you had a bankruptcy and foreclosure -- they'll appear on credit reports anyway, so there’s no sense trying to hide them -- and that they were due to medical and other problems which are now past. Sometimes this can sway a lender.

Additionally, while you might not qualify for a conforming loan (underwritten by Fannie Mae or Freddie Mac), which typically are the least expensive mortgages available, you might qualify for a portfolio loan from a lender who is willing to accept greater risks for a higher interest rate. My suggestion is that you contact a good loan broker. Ask agents, friends or others who are in real estate for recommendations in your area. He or she can review the details of your financial situation and give you a clear picture as to whether you can get a mortgage right now. And if you don’t qualify now, ask how long you might have to wait.

Finally, consider getting a land contract of sale (as your landlord mentions) or using a lease-to-buy option as a way of locking in the purchase of a property over time. However, be sure to have a good attorney review the documents before signing them.

-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent books are "How to Get Started in Real Estate Investing" and "How to Buy a Home When You Can't Afford It" (McGraw-Hill, 2002).

Submit your question to realestatejournal@wsj.com, with your first name and the city where you're located, which are required to publish your question. If your question is answered and posted, we will show your first name and city.

Although we can't acknowledge all e-mail, we'll answer as many questions as possible.

Email your comments to rjeditor@dowjones.com.