Capital Idea
When I was in law school, my dad advised me to take as many tax courses as possible, because every aspect of the law involves tax. So, in the spring of 1997, I took Income Taxation at 8:00 in the morning. I drank a lot of Mountain Dew that semester.
One of the important tax laws we learned about was the homestead exclusion. This rule was passed to prevent seniors from feeling ‘trapped’ in their homes out of fear of paying capital gains taxes upon its sale. So, the IRS provided taxpayers over the age of 55 with a one-time capital gains tax exclusion if they sold their home and reinvested the proceeds in a more expensive home within two years.
If the taxpayer didn’t want to invest in a new home, they could exclude up to $125,000 of capital gains on the sale. To qualify as a homestead, the taxpayer had to use it as their principal residence for at least three out of the previous five years.
Because almost every client would likely have questions about selling their home, I studied these rules thoroughly. Then, on August 5, 1997, President Clinton signed into law the Taxpayer Relief Act of 1997, which completely changed the homestead exclusion rules.
Under the new rules, there is no age restriction for the exclusion to apply. Further, it is not a one-time exclusion – it is unlimited. To qualify, the homeowner must use it as their principal residence for only two out of the last five years. Single taxpayers are allowed to exclude gain of $250,000, or $500,000 per couple. Plus, the homeowner is no longer required to purchase a new residence to take advantage of the exclusion.
As I expected, I have received tons of questions from clients about the capital gains tax consequences from selling their homes. For the first 25 years of my practice, my simple response was “don’t worry about it,” because the sales price for the vast majority of my clients’ homes was less than $500,000, let alone the gain.
However, over the last couple of years as the real estate market has exploded, I have had a handful of clients who have had to pay a capital gains tax after selling their residence. Most of them were waterfront property, which really has appreciated in value.
Because this has become more of an issue nationwide, Representative Marjorie Taylor Greene of Georgia introduced legislation that would eliminate any capital gains taxes from the sale of a homestead. Greene characterizes the tax as “an outdated, unfair burden – especially in today’s housing market, where values have skyrocketed.”
“Homeowners who have lived in their homes for decades, especially seniors in places where values have surged, shouldn’t be forced to stay put because of an IRS penalty,” Greene said in a statement announcing the No Tax on Home Sales Act. “My bill unlocks that equity, helps fix the housing shortage, and supports long-term financial security for American families.”
The National Association of Realtors has dubbed the tax a “stay-put penalty” because homeowners are disincentivized to sell their homes. The tax is “quietly distorting the housing market” by “locking in older homeowners, and strangling inventory just when America needs it most.”
A NAR study found that 34% of homeowners, or 29 million Americans, would exceed the $250,000 threshold were they to sell their homes, while 10%, or eight million Americans, would surpass the $500,000 threshold for joint filers.
When asked about the bill, President Trump said, “We are thinking about no tax on capital gains on houses.”
If the bill does pass, at least it will be easy for me to learn.
Reg P. Wydeven
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