Tax Planning

Under the new

rules, each house purchased and sold stands on its own in terms of income tax consequence.

by P. Michael Pruett

for the Business Journal

One of the best-known tax breaks for homeowners has been the gain deferral and the over-55 exclusion. With the Taxpayer Relief Act of 1997, these tax breaks have been improved and simplified for home sales that take place after May 6, 1997.

Under the new regulations, there are two simple rules to remember:

1. Ownership and occupancy of the residence by the homeowner for at least two years; and,

2. Exclusion amounts of $250,000 of the gain which is not taxed ($500,000 for married couples filing joint returns).

Unlike the old rule of a lifetime exclusion of $125,000, the new exclusion amounts are significantly increased, and there is no age requirement.

And the exclusion can be used repeatedly throughout the taxpayer's lifetime, as long as the ownership and occupancy tests are met.

This simplifies the task for many people who previously had to keep track of the cost and improvements on their residence, and the additional responsibility of tracking previously deferred gains on former residences.

These types of tax records could often span years, and even decades, for many people.

Since the new rules do not incorporate any type of gain deferral, each house purchased and sold stands on its own in terms of income tax consequence.

This is especially important for people who move from high-cost areas of the country to low-cost areas, which is a trend not uncommon in the Midwest and especially southwest Missouri.

If an individual moved from southern California to this area, for example, they would often find it difficult, if not impractical, to reinvest at least 100 percent of the proceeds from their California residence into a residence in southwest Missouri.

However, if they did not comply with the old replacement-cost requirements of spending as much or more on the new home as they received for the old home, then they would face onerous income tax liabilities.

Another group that will likely benefit from the new rules will be divorcing taxpayers.

A common mechanism used in property settlements is for one spouse to pay the other for his or her share of the equity in the home. The spouse that received the cash as part of the divorce would not incur a tax liability on the property settlement.

However, the spouse that ultimately owns and later sells the home would often have to pay income taxes on the sale of the residence because they could not afford to replace it with one of the same value.

If the potential tax consequences were not considered when the divorce/property settlement was calculated, then additional disagreements and conflicts

erupt in what is already a difficult situation.

Under the new rules, the exclusion amount is high enough ($250,000 for single persons) to eliminate an unexpected tax bill for many people, as long as the two-year ownership and occupancy tests are satisfied.

As with any income tax regulation, the general rule will not always fit everyone's situation.

Congress made an effort to accommodate certain situations in the interest of fairness.

For example, if you do not meet the two-year occupancy and ownership test because of a job transfer or for health or "unforeseen circumstances," then you may qualify for at least a partial exclusion from tax, based on a ratio of the qualifying months divided by 24.

It is also becoming more common for people to use part of their home as their place of business, and this may cause a portion of any future sales proceeds to be taxable, even if you otherwise qualify for the tax benefit.

If you think you may have a special situation, then it is important to research the regulations thoroughly or consult your tax adviser.

(P. Michael Pruett, CPA, is a partner with Elliott, Robinson & Company LLP, Certified Public Accountants.)

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