Excluding Gain on the Sale of a Home

By: Clayton H. Hale, Jr

As the size of a family increases, families traditionally seek to replace the home they are outgrowing with a larger one. As time goes by and parents become empty nesters it is not uncommon for thoughts to turn to downsizing or perhaps becoming snowbirds and moving to a warmer climate.

These, as well as other life changing events, such as relocation caused by the loss of a job or a promotion, divorce, the death of a spouse, the remarriage of a widow or widower, and the obligation of a family to settle the affairs of a parent who has been confined to a nursing home, all precipitate the need to sell the family home.

The sale of the family home often results in the realization of a substantial gain. For many it is the single largest economic gain of a lifetime and should raise questions about the tax consequences.

Many remember, and may have taken advantage of, the old rules which permitted gain to be deferred as long as the proceeds received on the sale of the old home were invested in a new home.

The current rules, however, no longer permit gain to be deferred by reinvestment. Rather, they provide for the exclusion of $250,000 of gain ($500,000 on a joint return) if the home was owned and used by the taxpayer as his principal residence for periods aggregating two years during the five year period ending on the date of the sale. The exclusion applies to only one sale every two years.

The rules sound simple, but there could be all kinds of specific tax challenges that complicate the sale of your home. Here are some questions you may have to answer to help obtain the gain you’re hoping for.

1. What if a 50 year old successful married couple moves to a larger home purchased for $750,000 and sells a house they paid $100,000 for 20 years ago for $600,000? The gain is not more than $500,000 but they might be surprised to find out they need some of the money they planned to use to fix up the new house to pay income tax. They may have forgotten that the $100,000 basis of the home they sold is reduced by the $50,000 gain on the house they purchased at age 25 and deferred when they purchased the $100,000 home. Alternatively, they may not have realized that because the wife worked at home and deducted home office expenses, including depreciation attributable to one of the ten rooms in the house, gain is recognized to the extent of the depreciation taken.

2. What if a retired couple purchases a second home in Florida and for six years spends six months and a day in Florida to avoid New York income tax. Then at the urging of their children they sell their New York home. Is their principal residence the New York home or is it the Florida home? The answer requires an analysis of many factors.

3. What if in the preceding example the facts show that the New York home is the couple’s principal residence and the couple spends four months in New York, three months in Florida and five months traveling around the country to visit their five children? Have they used the New York home as their principal residence for periods aggregating two years (twenty-four months) or more in the preceding five years? Again, it is a factual issue as to whether the temporary absences from the New York principal residence for travel count as time the couple occupied the New York home as their principal residence.

4. What if a married couple, after excluding gain on their first home, purchases their dream home which they are is forced to sell after 18 months because the husband is promoted and moved to company headquarters in California? Is there any relief from the once every two years rule?

5. What if a second marriage doesn’t work out and as part of the divorce settlement the wife receives the home her former husband owned and they lived in for several years before their divorce? Does the wife have to wait two years before selling or can she sell right away and count the time her former husband owned the house in meeting her two year ownership requirement?

6. What if in the preceding scenario the divorce settlement permits the husband to keep the house and grants the wife the right to use it as her home for five years? If the husbands sells the house after the five year period, is he denied the exclusion because he hasn’t lived in the home in the five years preceding the sale or can he count his former wife s occupancy following the divorce in meeting the two year occupancy requirement?

7. What if a married couple owned and occupied their principal residence for three years and the husband dies in September? If the wife sells the house in December, she can include the gain in a joint return with her husband and exclude up to $500,000 of any gain. If she waits until January, is her maximum exclusion limited to $250,000 because she no longer qualifies to file a joint return? What if she waits two years after her husband’s death to sell the house?

8. What would be the result in the previous example if the house were owned solely by the husband so that the wife met the two year occupancy ownership test, but failed the two year ownership test? Does it make a difference if the wife remarries before the sale?

9. What if a family moves their ailing widowed mother temporarily into a nursing home thinking that she will return home? After two years, when it becomes obvious that their mother’s return is not possible, they put the house on the market and it takes two years to sell. Is it too late to take advantage of the exclusion because their mother has only occupied the house for one year out of the last five?

10. What effect does the Supreme Court’s decision overturning the Defense of Marriage Act and the State’s recognition of same sex marriage have on the answers to the above questions?

As with many things in the tax law, it is not sufficient to just know the general rule. For anyone selling a home, an awareness of the issues raised by the foregoing questions, the foresight to plan ahead, and the wisdom to seek professional advice can result in substantial savings on one of the most significant economic windfalls of a lifetime.


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