`Unforeseen' events clarified in capital gains write-offs

Nation's Housing

September 01, 2002|By KENNETH HARNEY

THE FEDERAL government has just provided a partial answer to one of the longest-pending tax issues affecting American home sellers: how to figure capital gains tax write-offs when you don't qualify in terms of minimum number of years of ownership.

How much profit can you shield from the federal tax bite when an unforeseen circumstance forces you to sell your house sooner than you had planned?

The Internal Revenue Service and the Treasury simultaneously released policy guidance last week on the far-ranging aftershocks of one of the most horrendous unforeseen circumstances ever - the Sept. 11 terrorist attacks.

The guidance also gave hints of other, forthcoming clarifications of the capital gains rules for homeowners because of more commonplace types of unforeseen circumstances, from death to divorce.

Here's what last week's announcements covered: Under tax reform legislation enacted in 1997 and 1998, you as a home seller can exclude from federal taxation up to $250,000 (as a single filer) or up to $500,000 (if married filing jointly) of profits on the sale of your property, provided you have owned it and used it as a principal residence for at least two of the five years preceding the sale.

Under the law, taxpayers who sell before the minimum two-year period because of a change in place of employment, health or unforeseen circumstances may be eligible for a reduced tax-free exclusion.

For instance, a new homeowner who suffers a serious health problem requiring long-term hospitalization could qualify for a fraction of the maximum tax-free exclusion.

If he or she had owned the property for a year before the sale, the taxpayer could qualify for one-half of the maximum $250,000 tax-free exclusion, because eligible ownership and the home's use totaled half of the two-year requirement.

An 18-month ownership period would qualify for three-fourths of the maximum $250,000 exclusion.

Health and employment changes that affect the timing of sales are relatively straightforward under the law, but what did Congress really mean by "unforeseen circumstances" as a qualifier for tax relief?

Should Congress' vague wording allow anyone who sells before two years to conjure up an "unforeseen" compelling reason to claim a piece of the $250,000/$500,000 tax-free write-off?

Widespread gains

This is an especially relevant question today, when millions of American homeowners find themselves sitting on potentially large gains in high-inflation housing markets.

Since early last year, the Treasury and IRS have been working on regulations to resolve the "unforeseen circumstance" issue.

Last week's announcements made clear that taxpayers whose home sale timing was affected by the events of Sept. 11 may be able to claim a partial capital gains exclusion on their profits.

The government said, in effect, that Sept. 11 qualifies as an unforeseen circumstance for taxpayers who sold their homes earlier than the two-year minimum holding period as a direct result of the attacks.

Home sellers are considered "affected" by the rule if any of the following conditions apply: a spouse, home co-owner or person living with the home seller was killed in the attacks; the taxpayer's principal residence was damaged; the home seller, co-owner or co-resident lost his or her job as a result of the attacks; or the home seller had an employment change that made him or her unable to pay "reasonable basic living expenses for the household."

For example, say your spouse or a co-owner of your property perished in one of the attacks, leaving you with a house you had jointly purchased one year earlier.

In the months after Sept. 11, you found that the house no longer fit your needs or economic situation. You then sold the house in March.

Fortunately for you, the market had appreciated sharply, and you netted a $100,000 profit on the sale.

What taxes do you owe, given that you owned the home for 18 months - six months shy of the 24-month minimum? Based on last week's guidance, the answer is zero.

You are allowed to claim three-fourths of the maximum allowable exclusion for joint filers - that is, three-fourths of $500,000. Because that is far in excess of your gain, all $100,000 of it is tax-free.

Last week's advisories referred to broader categories of unforeseen circumstances that are likely to appear in the final home sale rules expected soon. Tops on the list: the death of a spouse. Next: "man-made disasters." And finally, acts of war.

Partial exclusion

All of these will qualify home sellers to claim a partial capital gains exclusion if the home is sold within the minimum two years.

But what about another circumstance that triggers huge numbers of early home sales: divorce?

The IRS declined to touch that hot potato for the record last week, but many tax professionals have urged that divorce be added to the growing list of homeowner financial calamities officially deemed "unforeseen."

Kenneth R. Harney is a syndicated columnist. His e-mail address is kenharney@ aol.com. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.

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