Though most people have heard of the recent
changes to the Internal Revenue Code ("IRC") rules regarding capital gain from
the sale of an individual’s principal residence, very few homeowners understand the
economic significance of IRS §121 and its easy mechanics. Prior to 1998, if a seller was
not over the age of 55, the seller of a home was forced to roll over all of his or her
profit from the sale of a home into a new home in order to exempt his or her hard earned
equity from immediate taxation at capital gain rates. This assumes the taxpayer satisfied
the requirement of the appropriate holding period. In effect, the rollover homeowner was
forced to purchase a new home on the sale of their previous residence for at least the
sale price amount of their previous home. This benefited the housing market, but not the
consumer who wished to use the equity in their home for children’s college expenses,
early retirement or investment opportunities.
In response to
the mandates of modern society, the legislature in 1998 enacted certain changes to
Internal Revenue Code §121 that provided the taxpayer with a tremendous wealth building
opportunity. Essentially, IRC §121 eliminated the requirement that taxpayers under the
age of 55 purchase homes of ever increasing value in order to protect their equity from
taxation.
Under IRC
§121, the gain from the sale of a taxpayer’s principal residence is exempt from
taxation up to $250,000.00 for an individual and $500,000.00 for a married couple filing a
joint return. This gain is calculated as the net of the original cost of the home plus
improvements minus the sale price and expense of sale, and in some cases, taking into
consideration depreciation expense previously taken by the taxpayer.
In order to
qualify for this generous exemption, the taxpayer(s) must, during a five year period
ending on the date of the sale of the home, have owned and used the property as their
principal residence for periods aggregating two years or more. Interestingly, however, the
IRS does not require one to live in the home exclusively for two years. For example, if an
individual or couple owned a home for four years and lived in and used that home as a
principal residence for eighteen months of that four years and then leased the property,
they could convert the property back to a principal residence for six more months and
receive a tax free gain on the sale of the property.
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Of course,
this presupposes that this conversion and sale were completed within five years. In other
words, an intelligent taxpayer can manipulate a lifetime of tax-free gain on his or her
"principal" residence for greater wealth building.
Obviously,
other limitations apply, but the most significant is that a taxpayer can only exempt one
sale every two years. IRC §121 was tailor made for the owner/builder who constructs a
home, builds immediate equity and sells the home after living in it for two years.
Conceivably, utilizing IRC §121, a vibrant real estate market and good luck, an
individual could earn substantial tax free gains of up to $500,000.00 every two years.
Limited only by one’s individual ability or desire to utilize IRC §121, the
legislature has provided individuals with an opportunity to create tax exempt gain prior
to the age of 55. This gain is potentially tax-free.
Whenever
possible the estate taxpayer should organize their financial affairs so as to pay the
least amount in taxes. end
Roger Croteau, in addition to being an
adjunct faculty member at Clark County Community College, and the University of Phoenix,
is a member of the Clark County Bar Association, State Bar of Nevada, State Bar of
Massachusetts, and the American Trial Lawyer’s Association. The law practice of Roger
Croteau may be reached by calling (702) 254-7775. |
