$500,000 IRS Tax Exclusion

The new $500,000 tax exclusion is now revalidated every two years! It used to be only once in your lifetime.

Primary-home tax exemption Thanks to the 1997 Tax Act, its repeal of the old home sales tax rules and its enactment of simple, new rules, most home sellers can now completely avoid tax on their sale profit by owning their home for at least two years of the five year period ending on the sale date. No sales made before May 7th, 1997 will qualify. If your spouse dies you must sell your home within the same year in order to claim the $500,000.

New Internal Revenue Code §121 says up to $250,000 of profit per qualified home seller (up to $500,000 for a married couple filing jointly) is tax exempt.

Even home sellers who used the old "over 55" rule and/or the "rollover replacement rule" can use this new tax exemption. To qualify, the seller must have owned and occupied the principal residence any two of the last five years before the sale.

For married couples, only one spouse need hold title to the home. However, the non-title spouse must meet the two-year occupancy requirement.

Absences due to physical or mental incapacity require only one year of residency during the last five years before the sale. This new tax break can be used once every 24 months.

What is a principal residence?

A principal residence is the taxpayer's primary dwelling, usually where he or she votes, files income tax returns, works, has a driver's license or spends the most time. A taxpayer cannot have more than one principal residence at a time.

Divorced and separated couples gain big tax benefits. When a home is occupied by a divorced or separated spouse and the other spouse lives elsewhere, if the "in" spouse qualifies for this new tax break, the "out" spouse also qualifies for up to a $250,000 home sales tax exemption.

If title to any real estate was transferred between spouses during the marriage or as part of a divorce, Internal Revenue Code §1041 says no gain or loss is recognized. It's a tax-free gift between spouses.

But such a divorce property settlement could result in the entire property sale gain being taxable to just one spouse.

Second-home tax exemption

At first glance, the new Tax Act appeared to have no effect on vacation or second home tax breaks. But thousands of vacation home owners are discovering that they can qualify for the major new $250,000 tax exemption reserved for principal residences.

A typical situation is a "snowbird" who owns a family home in the Midwest and a winter home in Arizona. Until now, the profitable sale of these second or vacation homes couldn't qualify for any tax exemptions.

They weren't principal residences, nor were they investment properties. But the 1997 Tax Act, as astute tax advisors have discovered, changed that. For example, suppose a husband and wife have owned a Florida winter home for many years, which they can now sell for a $200,000 profit.

If either spouse, or both spouses, lives in this residence as their primary residence for a total of 24 out of the 60 months before its sale, the profit can be tax-free. A qualified husband and wife filing a joint tax return can claim up to $500,000 of tax-free sales profits.

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