SALE OF YOUR PRINCIPAL RESIDENCE

All of the profit from the sale of your principal residence up to $500,000 if filing a joint return, $250,000 if single, is EXEMPT from all federal and Colorado income taxes, IF you satisfy both the Ownership and the Occupancy requirements described below, and have not taken any depreciation on the home after May 6, 1997.  Yes, you pay NO federal or Colorado income tax on that home sale profit, and, this exemption benefit regenerates itself every two years so it can be claimed again on the next qualifying home sale.  You can now move down to a lower priced house, or not even purchase and just rent, without fearing any tax consequences from the profitable sale of your home.  Since no notice of a qualifying sale is even sent to the IRS, taxpayers typically do not even have to report the home sale on their federal tax return, and most states follow this same rule.  Only the net profit on the sale of a personal residence exceeding the $500,000 or $250,000 exemption limits is taxable.  But, if you do not completely satisfy both the Occupancy and the Ownership period requirements described below, the entire net profit on the sale of your personal residence is fully taxable, unless you satisfy one of the Reduced Exclusion exceptions described below. 

Unfortunately, you cannot deduct any loss on the sale of your personal residence.  Also, both the old tax rule requiring the purchase of a higher priced new home to defer taxes on any gain, AND the old rule allowing a one-time $125,000 tax exclusion for taxpayers over age 55 have been eliminated. 

EXCLUSION DOLLAR LIMITATIONS:

Married taxpayers can exclude from taxable income the profit of up to $500,000, single taxpayers up to $250,000, on the sale of their personal residence.  This amount of tax-exempt gain is available each time a taxpayer sells a personal residence, as long as both the ownership AND the occupancy requirements noted below are met.

OWNERSHIP AND OCCUPANCY REQUIREMENTS:

To qualify for the net profit exemption, the property sold MUST be:

A.    Owned by, AND

B.    Lived in by the taxpayer, and/or the taxpayer’s spouse, as the taxpayer’s and/or the spouse’s principal residence for a period(s) aggregating two (2) years during the five (5) year period ending with the date of the sale. 

If these requirements are met, then the taxpayer can exclude the gain on the sale of the property up to the above dollar limits.  This limitation is met if either spouse filing a joint return meets these ownership and occupancy requirements. 

The exemption applies in most situations where the home has been placed into a living trust.  There are numerous special rules that need to be considered if more than one sale is completed in a two year period, for periods while living in licensed care facilities, situations where each spouse owns a home at time of marriage, and other special situations, so tax planning advice should be sought in those instances.

REDUCED EXCLUSION AVAILABLE:

In the event that a taxpayer sells a qualifying principal residence before satisfying the 24-month ownership and occupancy requirements described above, the taxpayer may exclude a portion of the gain IF the taxpayer meets one of the following three exceptions:

A.    A change in place of employment

B.    Health reasons

C.    Unforeseen circumstances.  There are a number of specific exclusions identified by the IRS, including health conditions, divorce or legal separation, birth of twins, change in employment status that results in the inability to pay housing costs and reasonable basic living expenses, and other similar situations.

This is defined as a “reduced exclusion.”  The amount of exempt gain is based upon the number of months the personal residence was owned and lived in by the taxpayer(s).  The profit exclusion amount for joint filers is $20,833 ($500,000 divided by 24) times the months the home was owned and occupied, and $10,416 ($250,000 divided by 24) if single.  So, if taxpayers filing a joint return move due to a job change by either spouse after owning and occupying a residence 13 months, the first $270,829 of net profit from the sale is exempt from taxes ($500,000 divided by 24 months times the 13 qualifying months). 

RENTAL OR HOME OFFICE USE:

If a property sale satisfies the ownership and occupancy tests, but the taxpayer claimed depreciation on the property as a home office or a rental after May 6, 1997, the amount of depreciation claimed is taxable at the time of sale, regardless of whether the gain is exempt under the above dollar limitation rules.  If a portion of the property is used as a home-office, then a portion of the gain may not be excludable, depending upon what portion of the property was the home-office.  It is also possible to convert a rental into a personal residence, and sell the property after meeting the ownership and occupancy requirements, and qualify for some or all of the exemption.  This area is quite complex, so obtain tax advice.

SALE AFTER USING THE $125,000 OVER 55 LIFETIME EXEMPTION, OR PRIOR TAX DEFERRAL OPTION HAD BEEN CLAIMED, (THE” OLD TAX RULES”):

Taxpayers who deferred a profit by reinvesting in a higher priced residence under the old rules are eligible for the full exemption under the new rules.  The cost basis for determining the gain on the sale of a primary residence using either of the above previous tax rules is the “tax basis” as calculated at the time that residence was acquired, plus the costs of any improvements.

ESTATE PLANNING CONSIDERATIONS:

Since the first $500,000 or $250,000 of net profit on the sale of a primary residence is now tax exempt in most cases, it is no longer necessary for older taxpayers to retain ownership of a home just to receive the “stepped up” basis that is available to the beneficiaries at the time of the death of the owner.  The property can be sold, often without any income tax liability due to the exemption amounts, and the proceeds used for any purpose desired, including gifting.  Shifting of wealth to avoid estate taxes and probate costs can now be more effectively accomplished in many cases by converting the residence to cash prior to death.