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IRS clarifies home sale rules

For many of us, the equity that we have built up in our homes is a comfortable nest egg for the future. At retirement, many people sell the family residence and move to smaller, less expensive home. Others, years away from retirement, may choose to sell when the nest empties out. With the spring home-buying season just around the corner, this is a good time to consider the tax implications of selling your home.

Help from Uncle Sam

The gain from the sale of your home is, potentially, subject to the capital gains tax. But a generous exclusion from that tax is available — $500,000 for married couples, or $250,000 for singles. And this tax break is generous not only in amount:

There is no age requirement for taking advantage of the exclusion and, in the right conditions, there is the opportunity to use the exclusion once every two years.

To qualify for the exclusion, the home for which you use your exclusion must be your principal residence, and you must have owned and occupied it for at least two of the previous five years before the sale.

The Internal Revenue Service recently provided answers to some questions about how the exclusion works:

1. Principal residence definition — Although the amount of time you spend in your home is a good indicator of whether it is your personal residence, it is not the sole consideration.

Other factors can include your place of employment, where your family lives, addresses on correspondence and tax returns, and where you maintain your banking relationships. Where you vote, the address on your driver’s license and the property on which you claim a property tax exemption also can help resolve the personal residence question.

2. Ownership and use requirements — Two years of ownership and occupation is defined as 24 full months or 730 days.

Short absences such as summer vacations still count as periods of use, but longer breaks, such as a one-year sabbatical, will not.

3. Marital status — When taxpayers who are not married jointly own a principal residence, as long as all rules are met, each of them is entitled to a $250,000 exclusion.

4. Vacant land — The home sale exclusion may include gain from the sale of vacant land that has been used as part of a principal residence, as long as the land sale occurs within two years before or after the sale of the residence.

Partial gain rules

If you don’t satisfy the two-year rule, the IRS allows you a partial exclusion for:

Employment change — The change may be yours, your spouse’s or that of a person whose principal place of abode is in your home. The new workplace must be at least 50 miles farther from the old home than the old workplace.

Health — The primary reason for the sale must be related to a disease, illness or injury. A physician’s recommendation of a change in residence for health reasons will suffice.

Sales relating to the necessity to care for a close relative who is sick may fall within this exception.

Unforeseen circumstances — The IRS has defined this term to include death, divorce or legal separation; becoming eligible for unemployment compensation; a change in employment that leaves you unable to pay the mortgage or reasonable basic living expenses; multiple births resulting from the same pregnancy; damage to the residence resulting from a natural or man-made disaster, act of war or terrorism; and condemnation, seizure or other involuntary conversion of the property.

The IRS has the discretion, too, to determine additional situations that will meet the definition.

Retroactivity — The IRS guidance specifically states that these new rules may be applied retroactively to principal residences that were sold in the past.

If you are selling your home and want to take advantage of the home-sale tax exclusion, consult your tax advisor well in advance of the sale in order to avoid any unpleasant surprises or complications.

For most of us, a home is the most expensive thing we will ever buy – or sell. Make sure you do it right.

Jeff Francis is vice president and senior investment officer for First Tennessee Brokerage. For more information about this or other personal finance issues, please call (865)971-2321 or visit your local First Tennessee financial center.

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