After years of wrangling with the Democrats, the GOP initiative to give a tax break to homeowners was approved as part of the sweeping new Taxpayer Relief Act of 1997. Now, home sellers will be able to exclude certain amounts gain from the sale of their principal residence from capital gains tax.
THE OLD LAW
In the past, the tax code provided a break only for senior homeowners. The code allowed a “one time” exclusion of up to $125,000 of capital gains tax on the sale of a principal residence to taxpayers over age 55. In addition, the law allowed younger taxpayers to “defer” their gain by rolling the proceeds of a home sale over into a new home that cost at least as much as the prior home. Unfortunately, this rule caused many problems for younger taxpayers, especially those jobs require them to move often, as a taxpayer with a $150,000 home might be moved to an area where homes had significantly lower values. As such, these homeowners often ended up with exorbitant homes in an effort to defer tax.
THE NEW LAW
The new law allows single homeowners to avoid capital gains tax on up to $250,000 of gain from the sale of a principal residence. Married taxpayers can save up to $500,000. In addition, the law still applies to those taxpayers over 55 who have already claimed the one time exemption. The law defines principal residence as a home you have used as your primary residence for two of the past five years. As such, in most instances, taxpayers will avoid capital gains altogether on the sale of their principal residences. The only other catch is that this exclusion can only be used once every two years. (This rule is an effort to discourage “real estate speculation” and to provide the exclusion for principal residences only).
WHAT LAW TO APPLY
The new law goes into effect retroactive to May 6, 1997. If you sold your home on or before May 6, 1997, you must use the old rules. If you signed a real estate contract prior to May 6, 1997 but the closing takes place after that date, you may choose between the old and new law. For any other sales, you may use the new law.