Capital Gains Tax on the Sale of Your Principal Residence

Has the tax bill signed by the President on August 5, 1997 impacted the real estate industry?

Yes! The bill made significant changes that benefit real estate including capital gains tax exclusions on the sale of a principal residence, a reduction in overall capital gains rates, penalty-free withdrawals from existing and new IRA's for the purchase of a home by a first time buyer, increased deductions for health insurance premiums for the self employed, clarifications of the home office deduction requirements and reduced estate taxes.

If I sell my home how will I be impacted?

The new tax bill grants married couples up to a $500,000 capital gains tax exclusion for the sale of a principal residence where the owner has resided two of the last five years. Singles enjoy a $250,000 exclusion. Any profits in excess of the caps will be taxed at the new lower capital gains tax rate. Best of all, this principal residence exclusion can be reused over and over again. Homesellers who have owned and lived in their homes for less than two years qualify for a smaller tax exclusion based on length of ownership/residnece.

Can I still "rollover" the proceeds from a home sale if I purchase a home of greater or equal value?

No. The "rollover" provision in current law which allowed an individual to avoid capital gains taxes by purchasing a home of equal or greater value has been repealed in favor of the exclusion.

What if I am over 55 years of age and I already used my one-time exclusion of $125,000? Can I take advantage of the new law?

Yes. Although the $125,000 exclusion for individuals over the age of 55 has been repealed, the new law allows any couple, regardless of age, to exclude from taxes up to $500,000 in capital gains or $250,000 for singles every two years for an unlimited number of transactions involving their principal residence.

I sold my home before the President signed the bill. Do I still qualify for a capital gains tax exclusion?

Maybe. Sellers and buyers who have signed a "binding contract" between May 7, 1997 and the day President Clinton signed the bill (August 5) are authorized to use either the existing rollover law or take advantage of the new tax provisions. Individuals who completed the sale of their home prior to May 7, 1997 are bound by the tax laws in effect at that time. For home sales after the August 5 date, the new tax laws are applicable.

Are losses on the sale of a residence deductible?

No. Taxpayers still cannot deduct losses on the sale of their residence.

What are the new capital gains rates?

Capital gains rates are based on an individual's taxable income. Under the 2003 law, capital gains rates are lowered from the previous rate of 20% to 15% for those in upper income brackets and from 10% to 5% for those in lower tax brackets for assets sold after May 6.

How long is the holding period for assets to qualify for capital gains tax treatment?

Thanks to the IRS Restructuring and Reform Act of 1998, assets held 12 months are eligible for capital gains treatment.

Is investment property taxed differently than other assets under the new bill?

The new budget plan specifies that at the time of sale of an investment property, any gains due to appreciation will be taxed at a reduced 15% rate and gains due to "depreciation recapture" will be taxed at 25%.

Have the rules governing 1031 "like kind" exchanges changed?

Yes, a separate new tax law, signed by President Bush on October 22, 2004, will amend the current capital gains law as it pertains to 1031 exchanges. Under the new law, a property that is acquired through a 1031 exchange and then converted to a principal residence must be held for five-years to qualify for the capital gains exemption. The new law pertains only to properties acquired through 1031 exchanges that are converted to principal residences, and not to properties bought as a principal residence or investment properties not converted to principal residences.

Can I withdraw money from my Individual Retirement Accounts (IRAs) for the purchase of a home?

The tax bill allows penalty-free withdrawals by grandparents, parents, children, spouses or principals of up to $10,000 from existing and newly created "American Dream" IRAs for the down payment and closing costs of purchasing a first-time home, after December 31, 1997.

ALL OF THESE MATTERS ARE SUBJECT TO REGULATORY INTERPRETATION. PLEASE CONSULT YOUR TAX ADVISOR.

Proposition 13

Proposition 13, approved by voters in 1978 implemented many changes in the state's tax laws:

• Capped property taxes at 1% of assessed value
• Rolled back assessed values to 1975 levels.
• Allowed for a 2% annual increase in assessed values to compensate for inflation.
• Required two-thirds voter approval of all local "special taxes".
  

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