At a recent listing appointment, the owner who’d had the home for many years as her primary residence asked me the following question for which I did not have an immediate answer: “Is there a one-time exemption from capital gains on the sale of your primary residence?”
Although such questions are best asked of accountants, I hustled back to my office and did some research. I discovered that there was once a one-time exemption for homeowners above the age of 55 with a one-time capital gains exclusion. Individuals who met the necessary requirements could exclude up to $125,000 of capital gains on the sale of their personal residences. The exclusion was intended to stimulate the real estate market and reward homeowners for their purchase and subsequent sale.
The over-55 home sale exemption was superceded by provisions in the 1997 Tax Reform Act. This act raised the amount of excludable gain to $250,000 per taxpayer, and also allowed for more than one exclusion per taxpayer per lifetime. As a result, single sellers are able to exclude $250,000 in gain each time they sell their primary residence after living in it for more than two years. Couples who file together are able to exclude $500,000 in gain from the sale of their primary residence after two years.
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
• owned the home for at least two years (the ownership test) and
• lived in the home as your main home for at least two years (the use test).
If you can exclude all of the gain, you do not need to report the sale on your tax return. If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040).
Don’t think you can only use this exclusion if you own a single family, traditional house. The act applies to any dwelling that you consider your primary residence, such as a houseboat, condo or townhouse, cooperative apartment, or a mobile home.
If you realize more than $500,000 in gain—which you may if I’m selling your house!—the excess gain will be subject to a significantly lower capital gain rate of 15% instead of the 25-31% capital gains tax on investment property gain.
If you’re interested in deferring taxes on the capital gains realized on the sale of investment property, check into 1031 exchanges. In a nutshell, a 1031 exchange is when the seller of an investment property defers their capital gains taxes on the sale, provided they buy another property or properties to hold as investment.
A basic premise of a 1031 exchange is that the taxpayer who sells relinquished property must be the same taxpayer who buys replacement property. This usually means that the vesting is the same for both the relinquished and the replacement properties. For example, John Doe’s name is on title to both properties involved in the 1031 exchange.
America Foy is a top producing real estate agent with Bay Sotheby’s International Realty in Oakland. Email him at email@example.com Follow him on Facebook (America Foy), Instagram @americafoyrealtor or Twitter @americafoy