If you are considering selling your home, you might want to pull the trigger before the end of 2008. The federal government determined that millions in taxes were being drained off each year because of the way investment property sales have been treated for tax purposes. On January 1, 2009, a provision in the housing bill HR 3221 plugs that hole and it’s investors who may end up high and dry.

Homeowners were happy to recycle–their exemptions, that is. Before HR 3221, people were allowed exemption from taxation on the first $500,000 of their home selling profits if they were married filing jointly or $250,000 if  filing singly. The only restriction was that they had to have lived in their homes for two out of the most recent five years. Vacation homes or investment properties that were converted to primary residences qualified for this treatment as well. This allowed property owners to sell their residences, exclude the capital gains, move into vacation or rental properties for a couple of years, and then sell them and exclude the gains again. Who needed to work for a living?

Turn out the lights….the party’s over. While it took some time, the government did finally catch on. HR 3221 contains a provision for calculating the gain on the sale based on how many years the taxpayer lived in the property versus how many years it was owned starting 1/1/09. Merely moving in for two years will no longer allow you to take advantage of the full exclusion available. To determine how much gain will be taxed, perform this calculation. Take the number of years the house was not used as a primary residence and divide by the total period of time the home has been owned starting January 1, 2009. Multiply that result by the gain on the sale of the home to get the taxable gain.

For example: A single taxpayer has owned a vacation home since 2000. In 2006, he moved in and lived there for 2 years, selling the property in 2008 and making a profit of $300,000 on the sale. He gets to exclude $250,000 from capital gains tax because he sold in 2008. But under the new rule (and this may eventually be interpreted differently, the IRS has yet to issue guidelines), the capital gain that can be excluded will be determined by the number of years the property functioned as a primary residence divided by the number of years the property was owned. If you own property, the ownership clock restarts 1/1/09. All currently-owned property will be treated for  tax purposes as though it was purchased on that date. So if you have lived in your former second home at least 2 years and are thinking of selling, you might want to either unload it now (to take advantage of the old guidelines) or move in and plan on staying at least two years. That way when the clock restarts it’s already your primary residence.

Otherwise, you will want to live in the property as long as you can before selling. For example, if you keep the property for 3 years, then move in for 2 years before selling, you get to exclude 40% of the capital gain and will have to pay taxes on 60% of it (because you lived in the home for 2 of the 5 years you owned it starting 1/1/09). The longer you live in the property before selling, the higher the portion of gain you’ll be able to exclude.

This is new law, and the IRS has yet to issue guidelines. Be wise and seek professional advice from a tax accountant or property lawyer when you are considering buying or selling your home so that you can determine the financial repercussions. However, with this new law coming into effect on January 1, now might be the time to pick up the phone.

Tags: hr 3221, new housing bill, new tax law, second home sale, tax on sale of home

This entry was posted on Tuesday, August 26th, 2008 at 11:10 am and is filed under Daily Pick. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.