The 2018 Tax Cuts and Jobs Act (TCJA) changed tax rates and brackets and included many other changes that will affect individual tax payers for the years 2018 – 2012. The act retained for the most part the status quo for taxes on long term capital gains including the sale of personal residences. Tax payers are permitted to retain, tax free, up to $500,000 (for married couples) in capital gain upon the sale of a personal residence. Single taxpayers may obtain up to $250,000.
To qualify for the exemption, the taxpayer must have occupied the home for at least two of the previous five years prior to sale. The IRS rules allow taxpayers who live in the property for less than two years the right to shield a portion of their gain from taxation. To qualify, the sale of the property must have been for “unforeseen circumstances”.
The law provides that this “proportional” benefit means that if a taxpayer lives in the property for one year instead of two (and meets one of the above reasons for sale), a single taxpayer may pay no tax on up to $125,000 worth of gain ($250,000 if married) as opposed to having to pay the tax that would otherwise be owed.
The original law unfortunately was unclear regarding the test for “unforeseen circumstances”. There was no consent on what the phrase actually meant although most interpreted it to mean change or loss of employment or a family health emergency. Even now there is little agreement on what constitutes “unforeseen circumstances” and one should seek legal and tax consultation.
The “two out of the last five year” rule (originally included in law in 1997) made for some interesting scenarios under which sellers might escape paying taxes. The seller did not have to be living in the home at the time of the sale, but merely must have lived in the home two of the last five years. One of the other aspects of this law was the ability for investors to move into and occupy a rental property (thereby converting it into a personal residence) for two years and then sell it and benefit from the up to $500,000 exemption. The IRS has now closed this loophole and new rules apply. An owner reoccupying a home after having rented it will have only a partial tax exemption unless the occupancy continues for another full five years.
The TCJA made other adjustments to the tax code regarding some limitations on the interest deduction for owner residences. Equity line loans are affected in that the interest on these loans is no longer deductible unless the proceeds are used for home improvements. Consumers are urged to seek tax advice should they have questions.
(See “Mortgage Interest Rules Clarified” for more information)