Sellers in future years will need to create a fraction against which to multiply their total gain. The numerator (top number) will be the time period the house was used as something other than a principal residence. The denominator (lower number) will be the total period of ownership.
The congressional Joint Tax Committee prepared a hypothetical example to illustrate how the computation would function. Say you are a single taxpayer and you buy a house next Jan. 1 for $400,000. You rent it out for two years and write off $20,000 in depreciation deductions. Then on Jan. 1, 2011, you decide to convert the rental house into your principal residence. You live there for two years. On Jan. 1, 2013, you move out and put the place up for sale. On Jan. 1, 2014, you complete the sale of the house for $700,000.
As under current law, the $20,000 of depreciation write-offs is treated as gross income. The two years of use as a principal residence qualifies you for some amount of tax-free exclusion on the $300,000 gain. But how much?
To figure it out, you divide your aggregate period of nonqualified use (the two rental years) by your total period of ownership (five years) and multiply that fraction (two-fifths or 40 percent) against your total gain of $300,000. The resulting number is the amount that's subject to capital gains taxation - $120,000 in this case. But the remaining $180,000 is tax-free.
The same scenario of facts under the current tax code would have allowed you to claim the maximum $250,000 exclusion for singles. The $70,000 difference in the tax committee's hypothetical illustrates why the tougher rule is expected to raise millions in tax revenues for the government year after year. If the facts were changed in the example and you lived in the house for five years (2011-16), you'd get the full $250,000.
Bottom line: If you plan to buy, reside in or sell a second home or rental investment property after Jan. 1, be aware of the new allocation formula.
CORRECTION: In a recent column about a home-purchase tax credit created by the new housing bill, I said that if you have not owned a house during the past three years and can go to closing before the end of next June, you might be eligible for up to a $7,500 credit against your federal taxes for 2008 or 2009, or $3,750 if you file taxes as a single person. I should have said $3,750 each if you are married filing singly.
kenharney@earthlink.net
