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We give you a rundown on what to expect
when selling your home.

One of the benefits of owning a home is the break homeowners get on their taxes. Additionally, thanks to recent changes in tax laws, selling your home also helps what you owe to the government each year. However, tax laws are extremely complex, and not everyone can benefit from the breaks. A recent Wall Street Journal Online article walks you through the basics of what to expect when selling your home and who may not benefit.

A 1997 change in tax law meant that millions of homeowners who sell their homes do not owe anything in capital-gains taxes. This change has become even more significant in recent years as housing prices have jumped. According to the National Association of Realtors, the median home price increased 15% from $179,000 in April 2004 to $206,000 in April 2005.

The Basics of Selling Your Home

Generally, if you sell your primary residence, you can typically exclude a gain of up to $500,000 if you are married and filing a joint return with your spouse, or $250,000 if you are single or if you are married and are filing separately. However, you have to meet certain eligibility conditions, including the marriage and joint filing status.

Additionally, to be eligible for the full exclusion, you typically must have owned your primary residence for at least two of the five years before the sale. However, even if you have to sell your home in less than two years after you purchased it, you may still be able to avoid paying significant taxes. The law “allows a reduced maximum exclusion if the sale occurred because of a change in your place of employment, health reasons or ‘unforeseen circumstances.’” “Unforeseen circumstances” aren’t defined in the revised law, but the Treasury Department has since given numerous examples, including legal separation, multiple births from the same pregnancy and change of jobs for your or your spouse that results in a loss of pay and inability to pay housing costs and living expenses.

Also, these exclusion amounts are not indexed for inflation. When calculating your cost basis, you also need to be sure to include additions and other home improvements, such as new heating systems, renovated bathrooms, etc. This full exclusion is not a once-in-a-lifetime offer: you can take advantage of it every two years. It is also important to remember that this exclusion only applies to your primary residence, not vacation homes or second homes.

What happens if your profit from the sale is greater than the exclusion? If you make a profit of more than the exclusion, you would not owe capital-gains tax on $500,000 of your gain (if the sale is of your primary residence, and you are married and filing jointly), but you would have to include the remaining gain in your taxable income.

The Winners and Losers

Although this law may appear to benefit everyone, there are many people who will not enjoy the tax breaks. When Congress changed the tax law in 1997, it also erased an old “rollover” provision that allowed homeowners to defer the tax on their gain if they sold their home and bought a new one that cost as much or more than the old one. Homeowners are no longer allowed to do this.

Also, the new law greatly benefits homeowners who are looking to downsize, but it hurts those who find themselves in a hot housing market where home prices have risen rapidly and homeowners are building up large gains. Under the old law, these homeowners could defer capital-gains taxes by buying another residence; under the new law, this is no longer possible, and homeowners will have to cough up the taxes for the gain on their old home.

The new law also replaced an old law that allowed a one-time exclusion of up to $125,000 for people age 55 or older. Also, as mentioned earlier, many experts feel that the new law is not generous enough for those living in hot real estate markets, such as New York or Los Angeles. Finally, the exclusions are not indexed to reflect inflation, and are not likely to be anytime soon.

What To Do?

Now that you understand who is eligible for the exclusion and what the potential problems are, what do you do? As discussed previously, since home prices are growing in many areas of the country, many homeowners may be exceeding the exclusion. In this case, according to Bob Trinz, a senior tax analyst at RIA, a New York-based tax information and software company, you may want to consider keeping your home and leaving it to your heirs. Under the current tax law, all built-up capital gains will typically disappear when the owner dies, meaning that the cost basis of the home to the heirs will be the fair market value as of the owner’s date of death, and not what the owner originally paid.

If you are still considering selling your home and know that you will have a gain that exceeds the exclusion, consider selling stocks or other capital assets that have decreased in value, advises Martin Nissenbaum, national director of personal income tax planning at Ernst & Young in New York. The losses from your capital assets can be used to offset your capital gains from the sale of your home, which would otherwise be taxable. Capital losses can be deducted against capital gains, and if your losses exceed your gains, you can deduct up to $3,000, or $1,500 if married and filing separately, or net losses each year against income. Excess losses can be carried over to future years. Note, however, that you cannot deduct the loss on the sale of your primary residence.

When in doubt about where you stand in relation to the new tax laws, it is always advisable to seek help. There are several online resources that can be helpful for homeowners looking to decode the tax laws, including the IRS’s Web site, www.irs.gov (look for Publication 523, “Selling Your Home”) and the Web site of the Federation of Tax Administration, www.taxadmin.org. Finally, you can always tap into the help of a C.P.A. or other qualified professional who can help you understand your specific situation.

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