On a recent call-in radio program focusing on capital-gains taxes, “Ruth from Seattle” asked about increasing the exclusion on the sale of a primary residence.
“We paid about $100,000 for this place nearly 35 years ago and the Realtors are now telling me it’s worth $825,000,” said Ruth, a widow. “If I sell it, I will have to pay capital gains on $475,000. Is there any chance the exclusion will be raised?”
Ruth posed a question that has been on the minds of many sellers – especially seniors who view their home as their only real asset. Not only has the real estate market rocketed higher since the tax law changed nine short years ago, but the once-generous exclusion now seems quite ordinary in most of the country’s expensive markets.
In order to qualify for the $250,000 exclusion ($500,000 for married couples) you must have owned and used the property as your principal residence for two out of five years prior to the date of sale. Second, you must not have used this same exclusion in the two-year period prior to the sale. So, the only limit on the number of times a taxpayer can claim this exclusion is once in any two-year period.
What Ruth was asking for was a one-time exclusion that would be greater than $250,000 for single people and $500,000 for couples. She said she would be “more than willing” to give up her rights to any additional home-sale exclusion if she could “protect” more of the equity in her long-time residence.
When President Clinton signed into law the Taxpayer Relief Act of 1997 on Aug. 5, 1997, he changed not only the $125,000, one-time home sale exclusion for people over 55 years of age, but also the “rollover replacement rule.” Under the old law, a taxpayer could defer any gain on the sale of a principal residence by buying or building a home of equal or greater value within 24 months of the sale of the first home. Tax on the gain was not eliminated, but merely “rolled over” into the new residence, reducing the tax basis of the new home.
If you sold a primary residence and failed to meet the requirements for deferral, the taxpayer faced a tax on current and previously deferred gain. The old law also contained a once-in-a-lifetime, $125,000 exclusion ($62,500 if single, or married and filing a separated return) of gain from the sale of the primary residence. The intent of the 1997 tax code, which replaced the “rollover” provision and $125,000 over-55 exclusion, was to allow most homeowners to sell their primary residence without tax – and not worry about keeping records. (If you live in an expensive area, it’s still wise to retain proof of the original cost of the home and significant improvements.)
If history is any indicator, the chances of Congress increasing the exclusion on the sale of a primary residence are remote. For example, before 1997, the tax-free amount was last raised – to $125,000 from $100,000 – on July 20, 1981. That followed 16 years of absolutely no increased benefit while some homes had tripled in value during the same time. The exclusion, which had jumped from $20,000 to $35,000 in 1976, then to $100,000 in late 1978, was terribly out of date and had not kept pace with inflation. Homeowners, especially retired folks, need more incentive to be mortgage-free. The one-time, over-55 exemption was becoming more of a one-time problem. Buying down had begun to carry the connotation of losing out.
What is often misunderstood is both the earlier one-time exclusion of up to $125,000 in gain for persons over 55 and the deferral of all or part of a gain by purchasing a qualifying replacement residence, are gone. You no longer can utilize parts of either portion and you absolutely do not have to buy a replacement home. People who used the $125,000 can make use of the new exclusion if they meet the two-year residency test. The law enables seniors to buy down to less expensive homes without tax penalties.
In 1995, I wrote a story urging Congress to consider raising the then one-time $125,000 exclusion on the sale of a primary residence. The piece was picked up by national wire services. I then got notes from people in the heartland Kansas, Oklahoma, Missouri – indicating they would be happy to trade places with homeowners who were even coming close to needing a $125,000 tax-free exclusion.
I wonder what they would say now when $250,000 and $500,000 is not enough to avoid capital-gains tax?
Next week: Pocket the exclusion and invest the remainder … tax free
Tom Kelly’s book “Cashing In on a Second Home in Mexico: How to Buy, Sell and Profit from Property South of the Border” was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com.
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