Tax Rules for Home Sellers

Many homeowners are getting an unexpected break from the government this year. The Treasury Department released rules that will allow far more people to escape paying capital gains tax when they sell their home.

At issue is the 1997 law, which typically lets you exclude as much as $250,000 of home-sale profit ($500,000 if you are married and filing a joint tax return) if you meet certain conditions. To qualify for the full exclusion, you must have owned the home and lived in it as your primary residence for at least two of the five years prior to the sale.

But those rules did not answer many key questions faced by homeowners who sell before the two years are up. Instead, it listed three broad exemptions. People who sell because of a "change in place of employment", "health", or "unforeseen circumstances". The IRS initially prohibited taxpayers from citing "unforeseen circumstances" until final regulations or "other appropriate guidance" was issued.

The changes, written to clear up ambiguities in the 1997 law, go well beyond earlier speculation. As expected, the rules will cut or even wipe out taxes for people who sell because of factors such as death or divorce. But in a bow to the difficult economic circumstances many people now find themselves in, the new rules also cover those who have lost their jobs or in some cases simply can no longer afford the mortgage. Even further afield; the tax break applies to people who sell their current house because of multiple births from the same pregnancy.

Even if you cannot fit into any of the safe harbors, you may still be able to win your case by relying on the facts and circumstances of your situation. Under such conditions, you would take the exclusion and then be ready to state your case if audited. If you are wrong, it could result in back taxes, interest, and even penalties. Moreover, the list of exemptions may expand in the future. The IRS commissioner can designate other situations that qualify.

The rules are expected to be formally issued before year-end. The Treasury and IRS may tackle many other thorny issues in these final regulations. Among them is one that often pops up for people who own more than one home: which one qualifies as the principal residence? In general, your principal home is the one where you spend a majority of the time during the year. But, as with so many tax issues, there can be exceptions.