Assess the Tax Consequences of Selling

Owning your own home has beenone of the best investments overthe past 5 years. Most peopleselling their home today are realizinglarge profits. If you sell your home for aprofit, what are the tax consequences?Many people mistakenly believe that aslong as they turn around and purchase amore expensive home, there are no taxconsequences. But this is no longer thecase. Under the Clinton administration,in May of 1997 Congress passed a newlaw that changed the tax rules regardingthe sale of primary residences.

Under the previous law, if you soldyour home and bought a more expensiveone, your gain on the sale was postponed.Then, when you turned age 55,you could downsize your home one timeand owe no capital gains taxes on thefirst $125,000 of the gain. The new rules,however, take a completely differentapproach to selling your home.

Today's Sell Rules

Now when you sell your home, you canexclude the first $250,000 of your gain. Anyprofit above that amount is immediatelysubject to long-term capital gains taxes. Toqualify for this exclusion, you must meetboth an ownership and use test.

During the 5-year period ending on thedate of sale or exchange of the home, youmust have owned and used the property asa principal residence for a total of 730 days,or 2 years. It's not a requirement that theuse days are concurrent, and short vacationscount as use days even if you rent thehome during those periods.

In addition, if you are married and filinga joint tax return, you can exclude up to$500,000 with the following requirements:

• Either spouse meets the ownership test.
• Both spouses meet the use test.
• Neither spouse is ineligible for theexclusion by virtue of having already takenone during the past 24 months.

Home Sweet Home Office

Often, people will use a portion of theirhome as a home office and deduct and/ortake depreciation for the portion thatrelates to their business activities. The portionof the sale of the residence that relatesto these activities is not eligible for theexclusion. For example, if you claim 10% ofyour home for business use, when you sellyour home, 10% of the sales price will notqualify for the exclusion and will be subjectto long-term capital gains taxes.

There are two important footnotes tothis law. First, there are a number of hardshipexceptions to the ownership and userules, including partial eligibility for exclusionfor such hardships as change ofemployment, health reasons, and unforeseencircumstances like natural disasters.Second, you can repeat this process every 2years. This means that if you were to sellyour home today, use the exclusion toavoid owing taxes, buy a new home, andthen sell that home 2 years later, you wouldstill be eligible for the $250,000 exclusion.

As in the past, it is critical that you maintainaccurate records of your cost basis inyour home. Most people don't keep goodrecords, which can create problems whenyou're selling your home. Set up a homefile and collect records of your original closingdocuments (eg, what you paid for yourhome) and all bills and invoices of capitalimprovements. For detailed informationabout this important law, go to www.irs.gov and request Publication 523.

is

the founder of the Welch Group,

LLC, which specializes in providing

fee-only wealth management services

to affluent retirees and health

care professionals throughout the

United States. He is the coauthor of J.K. Lasser's

New Rules for Estate and Tax Planning (John Wiley

& Sons, Inc; 2001). He welcomes questions or comments

at 800-709-7100 or visit www.welchgroup.com. This article was reprinted with permission

from the Birmingham Post Herald.

Stewart H. Welch III, CFP®, AEP,