For a brief period of time, the capital gains tax rule that went into effect last January favored high-end homeowners in an unexpected way.
The new rule, which permits special lower capital gains rates for property acquired after January 1, 2001 and held for at least five years, offers an opportunity for people who owned property on January 1, 2001 to treat the property as if was sold on that date and restart the capital gains clock. This deemed sale would occur on the tax return only - the owner of the capital gains property would never relinquish actual ownership of the property.
The potential tax effect of this rule for a homeowner facing a taxable gain on the sale of a personal residence that exceeds the $250,000 exemption, and for a married couple whose gain exceeds the joint $500,000 exemption, is that it appeared it was possible for the deemed sale to apply to a home, the owner could take advantage of the exemption that applies to gains on home sales, then a new exemption would apply when the home is finally sold, more than five years later.
To make things perfectly clear, the IRS has closed this loophole, now spelling out the fact that, although taxpayers are entitled to use the deemed sale with personal residences, the $250,000/$500,000 exemption on the sale of a personal residence does not apply in the case of the deemed sale.
Taxpayers who intended to exercise the option to use a deemed sale on their residence on their 2001 tax return, report the deemed sale of the home and take advantage of the exemption on the gain, may want to revisit this issue before filing their 2001 tax return next spring.