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What is the Tax Exclusion Rule for the Sale of a Residence?

The Taxpayer Relief Act of 1997 has replaced the old Rollover Residence Replacement Rule, IRS Code Section 1034, which allowed you to avoid paying tax on your profit from the sale of a principal residence so long as you bought a replacement residence within 24 months before or after the sale. It also replaces the old IRS Code Section 121 which allowed for a one-time exclusion to sellers who were over 55. The act applies to all sales on or after May 7, 1997, and allows a $250,000 ($500,000 for married couples) exclusion from the tax on the sale of your principal residence. You no longer need to buy another house of equal or greater value to claim the exclusion.

There are a few guidelines you need to follow to take advantage of this ruling. You may use it repeatedly but not more frequently than once every two years. The property must be your principal residence, not a second residence or a rental property. The residence may be in or out of the United States. It may be a detached house, a mobile home, a co-op apartment, or a condominium. You cannot have more than one principal residence at the same time.

There is a special provision in this 1997 Tax Act which allows both spouses to claim up to $250,000 of tax-free profits, even if one spouse is not living in the residence. For example, if an ex-spouse lives in the family home for at least two of the five years before the sale, then the nonresident spouse can also qualify for up to $250,000 of home sale tax exempt profit. However, the law requires that both spouses file a joint tax return in the year of the home’s sale, if not, then only a $250,000 tax exemption would be allowed to the spouse who hold title. There is also a special provision for a surviving spouse. The surviving spouse is allowed to claim up to $500,000 of principal residence sale tax exempt profit if the home is sold in the year of the other spouses’ death. In the event where two or more unmarried co-owners each meet the ownership and occupancy requirements, each co-owner may also claim up to $250,000 of tax exempt profit when the home is sold.

This exclusion virtually eliminates most record-keeping requirements when you know for certain that you will not experience a gain of more than $250,000 ($500,000 for married couples) on the sale of your residence. Your escrow or title company is no longer required to file Form 1099-S, which reported these qualifying home sales to the IRS. The new act did not change the rules concerning a loss on the sale of your residence. If there is a loss, it is still not tax deductible.

Related Questions

What are the rules if I acquired my residence in a like-kind exchange?

As of October 22, 2004, the American Jobs Creation Act of 2004 does not allow any tax exclusion if you sell your home within five years in the case where you have acquired the property through a like-kind exchange. Normally, a taxpayer would be allowed a tax exclusion of $250,000 ($500,000 for married couples) deduction if the property was used as a principal residence for at least two out of the five years before the sale. Taxpayers who convert rental property to a principal residence should be aware of this tax law change, which could limit their ability to exclude the gain on the sale of the residence.

What is the special tax treatment for the sale of a residence in California?

Proposition 60, which was approved in 1986, allowed persons 55 years of age or older who sell their principal residence and buy or build another residence of equal or lesser value within two years to transfer the old residence’s assessed value to the new residence, provided that the replacement residence was within the same county as the original residence. In addition, this program allowed the transfer of assessed valuation to a replacement dwelling located in a different county, provided that the county in which the replacement dwelling is located had adopted an ordinance allowing intercounty transfers of assessed value.  The program was expanded in 1988 by Proposition 90 which allows counties to make this program available to seniors moving in from another county.  Proposition 90 is considered a “local-option” law in that each county has the option of participating. If a county has adopted a Proposition 90 ordinance, it accepts transfers of property tax base assessments from other California counties. If the county that the homeowner is moving from does not have a Proposition 90 ordinance, this does not affect the eligibility of the homeowner.  A homeowner may benefit from this program only once from this tax exemption provision.

For specifics on this tax exemption program, go to the Los Angeles County Assessor’s website.

Is there a special tax exemption in California for property transfers between parents and their children?

Parents and grandparents are allowed to transfer the family house and other property to their children or grandchildren without property tax consequences. Proponents of the program argue that transfers within the family deserve special treatment in order to preserve family homes, businesses, and farms.  Proposition 58 was passed  in 1986 and was expanded by Proposition 193 in 1996  to provide a substantial reduction in property taxes for children or grandchildren who inherit (or otherwise receive) homes, farms, and other real property from their parents or grandparents if the property has been held for several years or more. In these cases, the property’s assessed value may be significantly less than its current market value. There is no income limitation or other “needs test” for participants in this program.

This program exempts from reappraisal a property holder’s principal residence, and up to $1 million in other real property, when the property is transferred between (1) parents and children, or (2) grandparents and grandchildren, provided that both parents of the grandchildren are deceased. This exemption from reappraisal provides that the transferred property retains the taxable value that it held prior to the transfer.
Refer to the California State Board of Equalization’s website:  http://www.boe.ca.gov/proptaxes/faqs/propositions58.htm for specific details.

[div class=”tipbox”]TIP
To prove occupancy as your principal residence, be sure to file your tax return from the residence. Voting and a driver’s license in the state is not enough proof to establish residency for the tax exclusion rule.[/div]

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