If you are 55 or older, or plan to be, you may be eligible for the “over 55 rule” principal residence sale $125,000 tax exemption. To qualify, Internal Revenue Code 121 requires passing three tests:
– You must be 55 or older on the day of your home sale.
The first test requires at least one homeowner who holds title be 55 or older on the day the principal residence is sold. It is not sufficient if the owner becomes 55 in the year of the sale. If you are not yet 55 but want to use your $125,000 tax break, a lease with option to purchase can be used to delay the home sale until after your 55th birthday.
If both husband and wife hold title to their home, only one co-owner need be 55 or older. Because just one $125,000 exemption is available per marriage, there is no need to wait until the second spouse becomes 55 before selling your home. Of course, if just one spouse holds title, that spouse must be 55 or older on the sale date.
However, when a principal residence is co-owned by two or more persons age 55 or older who are not married to each other, each qualified seller can claim a $125,000 tax exemption. For example, two friends decide to sell their principal residence which they own and occupy. If both co-owners pass all three tests, up to $250,000 of their sale profits will be tax-free ($125,000 for each qualified co-owner).
– You must own and occupy your home any three of the five years before its sale.
The second test requires the qualified principal residence seller who is at least 55 to have owned and occupied the home any three of the five years before its sale. These three years need not be continuous nor must the home have been owned for five years.
For example, you could have bought your home as recently as three years ago if you occupied it all that time. Vacations and extended absences for medical care, such as living in a convalescent home, count as home occupancy time.
Or, you could have moved out of your principal residence as much as two years ago, presuming you owned and occupied it for the three years before that. But vacation or part-time homes cannot qualify.
My favorite example is George and Barbara, who live in their Maine home from May 1 to Oct. 30 each year and in their Texas home the remaining six months annually. Neither their Maine nor Texas home meets the “over 55 rule” test because they occupied each residence for only 30 months during the last five years (six months each year).
– You can only use the $125,000 home sale tax break once.
The “over 55 rule” is available only once per lifetime. But if you used the $100,000 predecessor of this tax law before July 1, 1978, you can also use the $125,000 exemption.
However, any unused portion of the $125,000 exemption cannot be saved for future use. To illustrate, if your qualifying home sale profit is $75,000, the unused $50,000 portion cannot be saved for future use.
– Beware of the tainted spouse rule.
This once-per-lifetime rule means if a married or single person uses the $125,000 exemption, any person he or she marries is disqualified from using this tax break.
In second marriages, this can become very important. For example, suppose a husband and wife use their $125,000 home sale exemption. The wife dies. The widower then marries an “over 55” lady who wants to sell her home.
Unfortunately, she can’t use the $125,000 exemption because her new husband is a “tainted spouse.” However, she could have used her $125,000 exemption if she sold her home before marrying the tainted spouse.
The moral of the tainted spouse rule is, before the wedding, ask your intended spouse, “Honey, have you used your `over 55 rule’ $125,000 home sale tax exemption yet?” If the answer is “yes” and you plan to sell your home, sell it before marrying a tainted spouse.
– How to avoid tax if your home sale profit is more than $125,000.
If your home sale will produce a profit greater than $125,000, avoiding tax requires two steps. For example, suppose your home is worth $240,000 net after sales expenses and your adjusted cost basis is $40,000, resulting in a $200,000 net sale profit.
First, sell your principal residence for its $240,000 net or adjusted sales price. Presuming you qualify for the “over 55 rule,” subtract your $125,000 exemption to arrive at a $115,000 “revised adjusted sales price.”
Then, using the “rollover residence replacement rule” of Internal Revenue Code 1034, within 24 months before or after the sale buy a replacement principal residence costing at least $115,000 in this example. Doing so will defer tax on the remaining $75,000 of your $200,000 sale profit.
Your election to claim the $125,000 home sale tax exemption as well as use of the “rollover residence replacement rule” tax deferral should be made on IRS Form 2119 when filing your income tax returns. Your tax adviser can give you full details.
———-
Please note: Real estate laws differ from place to place, and laws of your area should be checked before making decisions on real estate problems. Letters should be addressed to Tribune Real Estate Features Service, 435 N. Michigan Ave., Suite 1400, Chicago, Ill. 60611.
