Homeowners enjoy generally favorable tax treatment when they sell their principal residence, thanks to a 1997 tax code change that eliminates taxes on capital gains.
But experts say that not everyone wins under the law, and it pays to be savvy about all the tax implications associated with buying and selling. Now that some economists are warning of a possible cooling in housing prices, it's as important as ever to be aware of what the laws mean to you.
First, some statistics. According to the National Association of Realtors, the national median price for an existing home was $206,000 in April, which was up 15 percent from April 2004, when it was $179,000, the Wall Street Journal reported.
The top economist for mortgage giant Fannie Mae, David Berson, predicts housing prices rising by about 6.5 to 7 percent in 2005, but there is “a chance” of regional declines in homes sales in 2006, he said at a press briefing.
Now for the tax rules. Some tips from Tom Herman of the Wall Street Journal:
Generally, if you sell your primary residence, and you've lived there for at least two years, you don't have to pay taxes on up to $500,000 of gain if you're married and filing jointly. An example provided by the Journal: Suppose you and your spouse bought your first home in the mid-1990s, have lived in it ever since, and your cost basis is $100,000. This year, you sell it for $600,000. Because of the 1997 law, you typically wouldn't owe any capital-gains taxes because your profit didn't exceed the maximum exclusion of $500,000. (The maximum exclusion for single taxpayers is $250,000.)
Using the same home as an example, if you sell for $1.1 million, no capital-gains taxes would be owned on $500,000 of your $1 million gain, but the other $500,000 would be taxable.
Most people benefit from the 1997 rules, but some don't because they can no longer defer capital gains by buying another primary residence. The so-called “rollover” provision was eliminated when the 1997 rules were put in place.
If you are a single person who netted a gain of $400,000 in a house sale and bought a new home right away for more than that, say $600,000, you could have deferred capital gains under the old rules because the gains were “rolled over” into the new home. Current law says you would owe capital gains tax on $150,000 - the amount over the maximum $250,000 single-person exclusion.
Some tax planners urge clients who are looking at gains that are above the exclusion amount to consider also selling assets that have lost money. Martin Nissenbaum, national director of personal income-tax planning at Ernst & Young in New York, told the Journal that the losses can then be used to offset some or all of the gain on home sale.
Conferring with a tax professional is always a good idea, considering the huge range of tax incentives, credits and rules out there.