This week’s FAQ: Combine home-sale exemptions?

A question that has been on the minds of many sellers – especially those who have lived in their homes for decades and now may be considering a sale – is the federal income tax exclusion.

In order to qualify for the $250,000 exclusion ($500,000 for married couples) you must have owned and used the property as your principal residence for two out of five years prior to the date of sale. Second, you 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.

What is often misunderstood is the earlier one-time exclusion of up to $125,000 in gain for persons over 55 and the deferral of all or part of a gain by purchasing a qualifying replacement residence. Both of those components are gone. You no longer can utilize parts of either portion and you absolutely do not have to buy a replacement home.

Persons who already used the $125,000 exemption years ago can make use of the new exclusion if they meet the two-year residency test. The law enables seniors to “buy down” to less expensive homes without tax penalties.

When the Taxpayer Relief Act of 1997 was signed, it changed not only the $125,000, one-time home sale exclusion for persons over 55 years of age, 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.

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. (If you live in expensive area, it’s still wise to retain proof of the original cost of the home and significant improvements.)