Seniors are particularly careful about guarding their assets. With little monthly income, older people still living in their longtime primary residences need to make the most of an eventual home sale.
Helen (last name withheld), from Gig Harbor, Wash., was concerned that she would be taxed on the entire sale of her home because she had already taken the "over 55" exclusion with her late husband on a previous home.
While she would like to move to San Diego, Calif., where her daughter has built a new unit above the garage, she was leery about paying a huge tax consequence.
The good news for Helen, and others like her who had already taken the "one-time" $125,000 exclusion, is that they are still eligible to take the $250,000 exclusion ($500,000 for married couples) on the sale of a primary residence. And they can do it every two years.
The Taxpayer Relief Act of 1997 changed not only the $125,000 one-time home-sale exclusion for persons over 55, but also the "rollover replacement rule." Under the old law, a taxpayer could defer any gain on the sale of a principal residence by buying or building a home of equal or greater value within 24 months of the sale of the first home.
Tax on the gain was not eliminated, but merely "rolled over" into the new residence, reducing the tax basis of the new home.
The intent of the 1997 tax code, which replaced the "rollover" provision and $125,000 over-55 exclusion, was to allow most homeowners to sell their primary residence without tax — and not worry about keeping records. Taxpayers no longer can utilize parts of either portion.
In order to qualify for the $250,000 exclusion ($500,000 for married couples), taxpayers must have owned and used the property as a principal residence for two out of five years prior to the date of sale. Second, they must not have used this same exclusion in the two-year period prior to the sale.
So the only limit on the number of times a taxpayer can claim this exclusion is once in any two-year period.
Helen said her Gig Harbor home (valued at $625,000) is now worth more than the sum of the original purchase price of $125,000 plus her exclusion of $250,000. However, there is a strategy she can use now where she can move in with her daughter, eventually pocket exclusion and roll the difference into another real estate investment that might help generate additional income or equity.
Guidelines have been adopted that allow investors who kept their home and used it as a rental property to take the exclusion without facing federal income tax liability.
For example, let’s say Helen moved into her daughter’s new "mother-in-law" unit in San Diego and rented out her Gig Harbor home for two years. Then, she sells her home and takes $375,000 ($125,000 plus $250,000 exclusion) cash-free.
If the home nets her $625,000, she can then roll the remainder ($250,000) into an investment property — perhaps a share of an apartment building. She can derive income from the investment during her lifetime and then eventually place it in a charitable trust to avoid future tax liability.
If you are a cash-strapped seller — especially a senior trying to fund your leisure years — take the time to research all the possibilities of the sale of your residence. There may be tax-free strategies available you have not considered.