Recent changes in the tax law have modified the tax benefits of selling a personal residence. For several years, taxpayers have been able to exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains from income taxation. However, provisions in the Housing Assistance Tax Act of 2008 have changed the rules. In the past, tax professionals advised taxpayers to sell real estate after living in their house for at least two years out of the five years ending on the date of sale. This allowed taxpayers to qualify for the capital gains exclusion because the exclusion was based on the last five years of ownership. Now, however, the exclusion is based on the period of time when the property is used as a primary residence. Any other use will not be excluded and could trigger capital gains tax.
Under the new rules, which took effect January 1, 2009, the amount of gain that will qualify for the exclusion is based on the amount of time that the house is actually used as a primary residence by the taxpayer. If the house is used other than as a primary residence (such as rental property, or as a vacation home), capital gains must be allocated between the time the property qualified as a primary residence and time it was used for non-qualifying purposes.
In order to qualify for the $250,000/$500,000 exclusion, the taxpayer needs to own and reside in the property as his or her primary residence for at least two years out of the five years ending with the date of sale. Under the provisions of the new law, the time that the taxpayer owns the home will be divided into “Qualifying use” and Non-qualifying use.”
Qualifying use means the property is being used by the homeowner or the homeowner’s spouse as a primary residence. Non-qualifying use means the property is not being used as a primary residence by either the homeowner or the homeowner’s spouse. Any gain from the sale of a home may need to be allocated between what gain is excluded and what gain is not excluded.
Any non-qualifying use prior to January 1, 2009 is disregarded for purposes of determining the capital gain allocation. In addition, temporary absences not exceeding a total of two years in aggregate will not jeopardize qualifying use. A property can maintain its status as a primary residence even if the homeowner is absent due to change in employment, health conditions, or other unforeseen circumstances.
Joseph W. Kenny is a director and shareholder of Hamblett & Kerrigan, P.A. and practices in the areas of estate planning and taxation. He is also a Certified Public Accountant with certification as a Personal Financial Specialist. You can reach Attorney Kenny by email at [email protected].