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Financial News & TipsAlan S. Moore / L’Observateur / October 14, 1998Selling one’s residence and moving into a smaller home or condo is seldom an easy decision, but at least part of the decision-making process is a little easier in light of an exclusion (part of the Taxpayer Relief Act of 1997) that eliminates most people’s federal tax liability on gains from the sale or exchange of their homes.

Under these rules, which apply to sales and exchanges of a principal residence after May 6, 1997, up to $250,000 of the gain from the sale of a single person’s principal residence is tax-free. For certain marriedcouples filing a joint return, the amount of tax-free gain doubles to $500,000. Thus, you no longer have to reinvest the sales proceeds bybuying a more expensive house in order to “roll over” (ie. avoid paying taxon) your gain. Also, the exclusion replaces the one-time exclusion of$125,000 of gain that applied to people over age 55. Since most peoplewill not owe any tax on the gain from the sale of a principal residence under these rules, the hassle of trying to document costs, expenses, and prices involving various residences over the years should be alleviated.

Like most tax laws, however, the exclusion has a detailed set of rules for qualification. Besides the $250,000/$500,000 dollar limitation describedabove, the seller must have owned and used the home as his principal residence for at least two years out of the five years before the sale or exchange. In most cases, sellers can only take advantage of the provisiononce during a two-year period. However, a reduced exclusion equals afraction of the $250,000/$500,000 dollar limitation, rather than a fraction of the realized gain. The fraction is based on the portion of thetwo-year period in which the seller satisfies the ownership and use requirements.

These rules can get pretty complicated if you marry someone who has recently used the exclusion provision, if the residence was part of a divorce settlement, if you inherited the residence from your spouse, if you sell a remainder interest in your home, or if you have taken depreciation deductions on the residence.

Not everyone will be happy with this exclusion. Homeowners who sell at aloss will still not be able to claim a deduction. Also, homeowners withprofits exceeding the $250,000/$500,000 limits may have to pay more taxes under these rules since Congress repealed the provision allowing owners to defer gains by rolling over home-sale proceeds into a new home costing the same or more.

On balance, though, the exclusion benefits most taxpayers. We finally havea tax break that most of us can actually use, and the tax savings can be substantial.

(Alan S. Moore is a financial advisor in the New Orleans office of LeggMason Wood Walker, Inc., a diversified securities brokerage and financialservices firm that is a member of the New York Stock Exchange, Inc. andSIPC.)

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