Congress has left this code provision virtually unscathed in it’s efforts to raise tax revenue. The house had earlier approved language that would have altered what constituted nonqualified use of a home when it passed H.R 3648. Fortunately, these proposed changes didn’t survive the Senate. Recently, Congress did put into place the Mortgage Forgiveness Debt Relief Act of 2007, which puts forth a new favorable rule allowing surviving spouses to fully utilize the exclusion.
Prior to May 7, 1997, taxpayers could avoid paying taxes on the gain attributed to profit from selling their home by using the proceeds to buy another, more-expensive home within two years. Another option available to taxpayers at least 55 years old at the time of sale was a once-in-a-lifetime tax exemption of up to $125,000 of gain.
The Taxpayer Relief Act of 1997 replaced the old rules providing a considerably more useful set of rules. IRC §121 gives sellers of a principal residence the ability to exclude up to $250,000 of gain per individual and for taxpayers married and file a joint return, a $500,000 exclusion if certain tests are met.
Ownership, Use, and Frequency Test:
In order to qualify for the full exclusion, the taxpayer must have “owned and used” the home as a principal residence for at least two of the preceding five years prior to the sale. The “use” test can include the period the taxpayer rented the home before buying it and may include the period a spouse owned the home. Generally the individual must own the home, it cannot be owned by an entity. The “frequency test” is met if the exclusion is used once every two years. Either spouse can meet the ownership test, however, both spouses must meet the use and frequency test. There are reduced exclusion rules for changes in employment, health, and unforeseen circumstances when the above tests are not met in full. Look for this in our next newsletter as we continue with the next installment of: Reaping the Tax Benefit of your Appreciated Home where we’ll cover strategies such as how to use the exclusion to shelter gains on the sale of business property.
The New Surviving Spouse Rule:
With the passing of The Mortgage Forgiveness Debt Relief Act of 2007, a surviving spouse may qualify for the full $500,000 exclusion beyond the year of death if certain conditions are met:
- The sale occurs no later than two years from the date of the first spouse,
- The general rules permitting the maximum $500,000 are met, and
- The surviving spouse has not remarried as of the date of the sale.
This is a pretty nice tax break. Under prior law, the house had to be sold in the year of death, (remember the married filing jointly requirement?) in order to utilize the full exclusion. With the passing of this new legislation, widows and widowers are afforded additional time to decide if it makes sense to sell the marital home and the time to do so in what is probably the most difficult period in one’s life.