If you are selling your primary personal residence, you don't need to use
the services of a neutral third party. As of May 7, 1997, the rules for sales of primary residences were changed dramatically.
However, many people, including some tax and real estate professionals, are
unaware of the changes.
The long-lived rules requiring reinvestment of sales proceeds were completely repealed. Likewise, the once in a lifetime exclusion for sellers 55 & over was also eliminated.
In their place was instituted a new law allowing up to $250,000 of profit from the sale of a primary personal residence per person ($500,000 per couple) to be excluded from taxation. The full amount is available if the seller(s) used the home as their primary residence for at least two (2) years out of the five (5) years prior to the sale.
This does no mean that the property had to be owned for a full five years, as
some believe.
If the property was used as a primary
residence for less than the full two years, a pro-rated exclusion may be available. This works out to about $342.47 of
tax free profit per day per person ($250,000 / 730). This is available if the move was made due to health, work, or other unforeseen circumstances. Health reasons can cover a multitude of situations, including just being sick of living there.
On 12/23/02, IRS
finally released its safe
harbor definitions for interpreting the law. They are summarized on
this page.
Other reasons must be analyzed on a case by
case basis. While many people interpret the IRS's lack of definitive
guidelines as a ban on anything not specifically spelled out, I have always
looked at it differently. If IRS has not explicitly declared something to
be illegal, that leaves an opportunity to interpret the underlying tax law to
allow it. It disgusts me to hear of tax pros advising clients against
doing something just because IRS has not yet issued official regulations.
That is crazy. While IRS has the luxury of being able to take its sweet
time in developing its guidelines, those of us in the real world need to deal
with real life issues in more timely manner.
Vacant Land
The home sale exclusion can include gain from the sale of vacant land that has
been used as part of the principal residence, if the land sale occurs within two
years before or after the sale of the dwelling unit. The land must be adjacent
to land containing the dwelling unit, and all other requirements of Section 121
must be satisfied. The sale of the land and the sale of the dwelling unit are
treated as one sale for purposes of the $250,000/$500,000
exclusion limitation amounts.
Any profit above the excluded amount is taxable regardless of what is done with the money.
If the property was owned less than 12 months, it will be subject to ordinary
income tax rates. If it was owned for more than 12 months, it will qualify
for the lower long term capital gains tax rates.
As has always been the case, no deduction is allowed for losses on the sales of personal residences.
This only applies to sales of primary personal residences. It does not apply to sales of second personal residences or rental properties. Sales of those kinds of properties require the use of a
1031 tax deferred (aka Starker) exchange in order to avoid the capital gains tax.
You can see all of the rules for the sale of a residence by obtaining IRS's Publication 523. This is available at most IRS offices, by phone (1-800-829-3676) and from the
IRS website in downloadable
PDF format
and in browser
friendly html.
