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SALE OF YOUR PRINCIPAL RESIDENCE  

All of the profit from the sale of your principal residence up to $500,000 if filing a joint return, $250,000 if single, is EXEMPT from all federal and Colorado income taxes, IF you satisfy both the Ownership and the Occupancy requirements described below, and have not taken any depreciation on the home after May 6, 1997.  Yes, you pay NO federal or Colorado income tax on that home sale profit, and, this exemption benefit regenerates itself every two years so it can be claimed again on the next qualifying home sale.  You can move down to a lower priced house, or not even purchase and just rent, without fearing any tax consequences from the profitable sale of your home.  Since no notice of a qualifying sale is even sent to the IRS, taxpayers typically do not even have to report the home sale on their federal tax return, and most states follow this same rule.  Only the net profit on the sale of a personal residence exceeding the $500,000 or $250,000 exemption limits is taxable.  But, if you do not completely satisfy both the Occupancy and the Ownership period requirements described below, the entire net profit on the sale of your personal residence is fully taxable, unless you satisfy one of the Reduced Exclusion exceptions described below.  Unfortunately, you cannot deduct any loss on the sale of your personal residence.     

EXCLUSION DOLLAR LIMITATIONS:

Married taxpayers can exclude from taxable income up to $500,000, single taxpayers up to $250,000, of the profit on the sale of their personal residence.  This amount of tax-exempt gain is available each time a taxpayer sells a personal residence, as long as both the ownership AND the occupancy requirements noted below are met.  Beginning January 1, 2008, there is a special rule for a surviving spouse that allows them to claim the $500,000 exemption if the home is sold within 2 years of the spouse’s date of death and the requirements to qualify for the $500,000 exclusion had been met at the time of the spouse’s death. 

OWNERSHIP AND OCCUPANCY REQUIREMENTS:

To qualify for the tax exclusion of the net profit, the property sold MUST be:

A.   Owned by the taxpayer, and/or the taxpayer’s spouse, AND

B.    Lived in by the taxpayer, and/or the taxpayer’s spouse, as the taxpayer’s and/or the spouse’s principal residence for a period(s) aggregating two (2) years during the five (5) year period ending with the date of the sale. 

If these requirements are met, then the taxpayer can exclude the gain on the sale of the property up to the above dollar limits.  This limitation is met if either spouse filing a joint return meets these ownership and occupancy requirements.  Time spent in a nursing home counts as occupancy time. 

The exemption applies in most situations where the home has been placed into a revocable living trust.  There are numerous special rules that need to be considered if more than one sale is completed in a two year period, for periods while living in licensed care facilities, situations where each spouse owns a home at time of marriage, and other special situations, so tax planning advice should be sought in those instances.

REDUCED EXCLUSION AVAILABLE:

In the event that a taxpayer sells a qualifying principal residence before satisfying the 24-month ownership and occupancy requirements described above, the taxpayer may exclude a portion of the gain IF, ONLY IF, the taxpayer meets one of the following three exceptions:

A.   A change in place of employment

B.    Health reasons

C.    Unforeseen circumstances.  There are a number of specific exclusions including health conditions, divorce or legal separation, birth of twins, a change in employment status that results in the inability to pay housing costs and reasonable basic living expenses, and other similar situations.

This is defined as a “reduced exclusion.”  The amount of exempt gain is based upon the number of months the personal residence was owned and lived in by the taxpayer(s).  The profit exclusion amount for joint filers is $20,833 ($500,000 divided by 24) times the months the home was owned and occupied, and $10,416 ($250,000 divided by 24) if single.  So, if taxpayers filing a joint return move due to a job change by either spouse after owning and occupying a residence 13 months, the first $270,829 of net profit from the sale is exempt from taxes ($500,000 divided by 24 months times the 13 qualifying months).   

RENTAL OR HOME OFFICE USE:

If a property sale satisfies the ownership and occupancy tests, but the taxpayer claimed depreciation on the property as a home office or as a rental after May 6, 1997, the amount of depreciation claimed is recaptured and become taxable at the time of sale, regardless of whether the gain is exempt under the above dollar limitation rules.  It is also possible to convert a rental into a personal residence, and sell the property after meeting the ownership and occupancy requirements, and qualify for some or all of the exemption.  This area is quite complex, so obtain tax advice.  NEW rule after January 1, 2009!  After that date the exclusion amount WILL be reduced by any periods when the owner does not occupy the property as his/her personal residence starting in 2009.  This rule does not apply to homes purchased before January 1, 2009 and ONLY applies if the first use of the home after the purchase was as a rental or vacation home.  If the home purchased either pre or post 2008 was first used as a personal residence and then converted to a rental, the old exclusion rules still apply.  Example:  A single taxpayer purchases a property and uses it as a vacation home or rents it out for the first two years before occupying the property as a principal residence for the next three years prior to a sale.  The two year occupancy requirement is met but the maximum home sale profit exclusion will be 60% of $250,000, $150,000, since three out of five years is 60%.  Any periods of personal or rental use prior to 2009 will be ignored. 

1031 EXCHANGE NOT AVAILABLE:  The Section 1031 tax deferred exchange rules do not apply to personal residences.  If a personal residence is converted into a rental, then the 1031 rules can be used. 

CONVERTING AN INCOME PROPERTY INTO A PERSONAL RESIDENCE AFTER A 1031 EXCHANGE:

 Taxpayers who deferred a profit on the sale of an investment property through a 1031 exchange and later convert the property into a personal residence are eligible for the $250,000 or $500,000 exclusion.  BUT, if the property is purchased after October 22, 2004, the taxpayers MUST own the property for AT LEAST five (5) years from the purchase date to qualify, and the depreciation after May 6, 1997, must be recaptured at a sale.  The reduced exclusion rules ARE NOT available in this circumstance.  

ESTATE PLANNING CONSIDERATIONS:

Since the first $500,000 or $250,000 of net profit on the sale of a primary residence is tax exempt in most cases, it is no longer necessary for older taxpayers to retain ownership of a home just to receive the “stepped up” basis that is available to the beneficiaries at the time of the death of the owner.  The property can be sold, often without any income tax liability due to the exemption amounts, and the proceeds used for any purpose desired, including gifting.  Shifting of wealth to avoid estate taxes and probate costs can now be more effectively accomplished in many cases by converting the residence to cash prior to death. 

The above information is general in scope.  Tax advice should be sought on any situation other than the basic sale of a primary residence by a taxpayer who has owned and occupied the home for at least two continuous years and has never used the property as a rental or claimed it as a home-office.  Also, estate planning requires evaluating all aspects of an estate, so tax advice should be sought.

 

IRS required disclaimer:  IRS regulations require us to advise you that, unless otherwise specifically noted,  any tax advice contained in this communication (including attachments, enclosures, or other accompanying materials) was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions; furthermore, this communication was not intended or written to support the promotion or marketing of any transaction or matters it addresses.

 

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