A popular tax-savings loophole regarding capital gains taxes on some primary residences has been impacted by the 2008 Housing and Economic Recovery Act. The law places new restrictions on wealthy homeowners who own 2 or more homes and plan to “house hop” to avoid paying capital gains taxes. Although this law is almost 2 years old, I thought it would be useful to explain it in more detail, since many of my clients have questions about it.
Under previous law those who sell a house for profit after living in it as their primary residence for 2 of the past 5 years would not have to pay capital gains taxes on $250,000 of the gain for a single person or $500,000 for a married couple filing jointly.
Some taxpayers have avoided the capital gains tax by selling their primary residence, claiming the full tax exclusion, then moving to a 2nd or 3rd home that they have owned for some time making it their primary residence which they then sell and pay little or no capital gains tax. The new law states that the gain may not be excluded for periods of “non-qualified” use, basically the period of time the house was not used as the taxpayer’s primary residence.
While the change to the law will affect only a small minority of homeowners it will cause some tax headaches for a few. Partial exclusions will still be available in some cases and there are some special rules for members of the uniformed services and federal employees. Here are the basics to remember:
** The new law is effective for sales beginning in 2009
** Partial exclusion may still be available if the home was sold due to a change in place of employment, for health reasons or “unforeseen circumstances” such as the death of a spouse.
** The tax exclusion does not apply to portions of the gain attributable to depreciation allowed for rental or business use of the principal home for periods after May 6,1997.
** The gain may not be excluded for periods of “non-qualified” use or any period when the property isn’t used by the homeowner, spouse or former spouse as a principal residence.
Here is an example of the “unqualified use” rule:
A married couple buys a home on January 1, 2009 for $600,000 and plans to hold it as an investment. On January 1, 2012 they begin using it as their principal residence. They live thee 2 years and sell it on January 1, 2014 for $1.1 million, a profit of $500,000.
Under the old law, the couple would have excluded the entire $500,000 gain from their taxable income. Under the new law they can only exclude $200,000-two fifths-since the other $300,000 would be considered non-qualified because of the 3 years the home was not their principal residence. For more information consult a tax professional who may be able to identify any exceptions or other important points for individual situations.