How it works
Utilization of this tax exemption is one of the safest investment strategy for the conservative investor who wants to take few risks, not to mention for fixer upper house investors. Under this strategy, the investors can quality for the least expensive loan, the owner-occupied loan. There is no need to worry about tenants destroying your rental property or not paying the rent. You completely control the investment by living in the property yourself. When you sell, you have the opportunity to bring in up to $500,000 tax-free money every two years.
Here is an example to show how the exclusion works, illustrated in Table 1. You and your wife file jointly and you continuously buy and sell homes over the years, each time purchasing a more expensive home as a replacement. Let’s say that you bought a house for $300,00. For the last 5 years you have owned the home and it is now worth $600,000, with $300,000 worth of accumulated gain. If you were to sell your home now for $600,000, without the tax exemption you would be subject to a capital gains tax on $300,000. The amount of taxes saved with the tax exemption would be $84,000. Table 1 also illustrates other amounts of gains.
Home Selling under the Taxpayer Relief Act Exemption
(assuming a 28% tax bracket)
Home/ purchase price/sales price/ capital gain/ tax saved
#1/ $150,000/ $200,000/ $50,000/ $14,000
#2/ $200,000/ $300,000/ $100,000/ $28,000
#3/ $300,000/ $600,000/ $300,000/ $84,000
Ownership and Use Tests
To qualify for the tax exclusion, you must pass both the ownership and use tests. This simply means that during a 5-year period, ending of the date of sale, you have:
1.) Been owner of the house for 2 years (ownership test)
2.) Lived in the home for w years and it was your main residence (use test)
Maximum Amount of Exclusion
A total amount of $250,000 can be excluded if all of the following are true:
1. You meet the ownership test
2. You meet the use test
3. You did not exclude the gain from another home sale during the 2-year period
A total amount of $500,000 can be excluded if all of the following are true:
1. You are married and filed a joint return for the year
2. Either you or your spouse meets the ownership test
3. Both you and your spouse meet the use test
4. Neither you nor your spouse excluded gain from the sale of another home during the 2-year period ending of the date of the sale.
Can You Get a Partial Exemption?
Unforeseen circumstances may allow you to claim a reduced exclusion if either one of the following is true:
1. You did not meet ownership and use tests due to :
- a change in location of employment
- health problems
- unforeseen circumstances (see below).
2. Your exclusion would have been disallowed because you sold more than one home during a 2-year period, except that you sold the home due to :
-a change in location of employment
Unforeseen circumstances can include:
2. Divorce or separation
3. Not eligible for unemployment compensation
4. Multiple births from the same pregnancy
5. Damage to the home from natural disaster, war, or terrorism.
6. Condemnation, seizure, etc.
In these cases, the amount of capital gains tax the could be excluded would be based on the number of months that the home owner lived in the home during a 24-month period. If a home owner couple lived in their home for 12 months, they could exempt 50% of the $500,000 exclusion, or $250,000.
What are the advantages and disadvantages of becoming a serial home buyer/seller using the tax exemption?
The next installment we will examine that question.
Serial Home Seller Tax Exemption, Part 3
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