Dear Clients and Friends:

Selling one's residence and moving into a smaller home or condo is seldom an easy decision, but at least part of the decision. However part of the decision-making process is a little easier in light of an exclusion that eliminates most people's federal tax liability on gain from the sale or exchange of their homes.

Under these rules which apply to sales and exchanges of a principal residence after May 6, 1997, up to $250,000 of the gain from the sale of a single person's principal residence is tax-free. For certain married couples filing a joint return, the amount of tax-free gain doubles to $500,000. Thus, you no longer have to reinvest the sales proceeds by buying a more expensive house in order to "roll over" (i.e., avoid paying tax on) your gain. Since most people will not owe any tax on the gain from the sale of a principal residence under these rules, the hassle of trying to document costs, expenses, and prices involving various residences over the years should be alleviated.

Like most tax laws, however, the exclusion has a detailed set of rules for qualification. Besides the $250,000/$500,000 dollar limitation described above, the seller must have owned and used the home as his principal residence for at least two years out of the five years before the sale or exchange. In most cases, sellers can only take advantage of the provision once during a two-year period. However, a reduced exclusion is available if the sale occurred because of a change in place of employment, health, or other unforeseen circumstances. As part of the IRS Restructuring and Reform Act of 1998, Congress clarified that the amount of the reduced exclusion equals a fraction of the $250,000/$500,000 dollar limitation, rather than a fraction of the realized gain. The fraction is based on the portion of the two-year period in which the seller satisfies the ownership and use requirements.

These rules can get pretty complicated if you marry someone who has recently used the exclusion provision, if the residence was part of a divorce settlement, if you inherited the residence from your spouse, if you sell a remainder interest in your home, or if you have taken depreciation deductions on the residence.

Not everyone will be happy with this exclusion. Homeowners who sell at a loss still will not be able to claim a deduction. Also, homeowners with profits exceeding the $250,000/$500,000 limits may have to pay more tax under these rules since Congress repealed the provision allowing owners to defer gains by rolling over home-sale proceeds into a new home costing the same or more.

We finally have a tax break that most of us can actually use, and the tax savings can be substantial. I would be happy to go over the specifics of your situation with you to determine whether a sale of your residence would qualify for this tax break. You can contact me at (315) 363-3338 for more information.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner