When Congress changed the tax rules for selling a home, the aim was to ensure that most taxpayers would never owe tax on the sale of a principal residence. But for some retired homeowners, these new tax rules are a mixed blessing. The current tax law states that married joint filers may exclude from tax up to $500,000 in capital gains on the sale of a principal residence; single taxpayers can exclude up to $250,000. To qualify, taxpayers must have owned and lived in the home for at least two of the five years before the sale. Many retirees, however, have been homeowners for decades, and thus may have built up capital gains that exceed the limits. Perhaps more significant, retirees are more than likely to have endured some of life’s major events, such as widowhood and remarriage, which can restrict the amount of gain that a home seller can shield.
Thankfully, the news is not all bad. Some of the new provisions actually address tax issues that the old law ignored, such as the special needs of divorced home sellers or of retirees who sell vacation homes.
Following are six pointers on the home-sale tax provisions that you should be aware of before you sell:
- Your gains may be greater than you think. When adding up the gain on your sale, you must count not only the profit on your present home but also the gains from the previous home sales that you deferred as you traded up over the years. To find the amount, check the Form 2119 that you filed with your tax return when you sold your previous home. That form shows the accumulated deferred gain on all your earlier home sales. If your total gains exceed $500,00 for joint filers (or $250,000 for single filers) you owe capital gains tax on the excess.
- If you sell your home after the death of your spouse, more of your gains may be subject to tax than you expect. In general, widowed taxpayers who do not remarry must start filing as single taxpayers in the year after their spouse’s death. (For example, if your spouse died in 1997 and you did not remarry, you had to file as a single taxpayer starting on your 1998 return). As a single filer, you are limited to $250,000 exclusion, no matter how long you shared your home with your spouse before his or her death.
One consolation: If you owned your home jointly with your spouse, you get a so-called step up in basis on his or her share of the gain. Say, for example, that the house has increased in value by $600,000 between the time that you bought it and the date of your spouse’s death. Your spouse’s share of the gain–$300,000–is forever untaxed. Accordingly, if you sell the home as a single filer after your spouse’s death, you’ll owe tax on $50,000 of gain, which is your $300,000 share of the gain minus the $250,000 exclusion.
- If you remarry after being widowed, you shouldn’t overestimate your exclusion. Assume, for example, that your new spouse moves into the home that you have owned and lived in for many years. If you sell the house before you have both lived there for at least two years, you will be limited to the $250, 000 exclusion that is generally applied to single filers-even though you filed a joint return with your new spouse. Reason: You meet the law’s test for having lived in the house for at least two years before the sale, but your new spouse does not.
A married joint filer is also restricted to$250,000 exclusion if one of the spouses has an exclusion on the sale of some other principal residence within two years of the sale of the current residence.
- Check out the loophole for homeowners who must move to a nursing home. If you move into a nursing facility before you’ve lived in your home for at least two of the five years before the sale, you made still be able to claim the exclusion when you sell. Here’s why: As long as you owned and lived in the house for at least one year before moving into the nursing home, the tax law counts any time that you spend in the nursing facility as the time you lived in your own home. To qualify for this tax break, the person entering the nursing home must be physically or mentally incapable of self-care at home and must move into a facility that is licensed to care for patients with his or her condition.
- If you were divorced and moved out of the family home, don’t underestimate your exclusion. If you retained sole or joint ownership of your house after a divorce but haven’t lived there for at least two out of five years before the sale because your ex-spouse lived there, you may nevertheless exclude from tax your share of the gain up to $250,000-when the house is sold. To qualify, your ex must have been living there under the terms of your separation or divorce agreement for at least two of the five years before the sale.
- Strategize to exclude the gains on the sale of your vacation home too. Let’s say you sell your principal residence in the frozen north, reap the tax-free gains and then move into your vacation home in a temperate zone. As long as you own and live in the vacation home as your principal residence for at least two of the five years before the sale, you can pocket tax-free gains again.