Buying a home is the single most valuable investment most taxpayers make.
Fortunately, the tax law provides numerous tax benefits to encourage home ownership, including deduction of home mortgage interest, certain prepaid mortgage interest premiums, real estate taxes, and expenses on maintenance of a home office. In addition, certain first time home buyers may make penalty-free withdrawals from their IRAs to use as a down payment when purchasing a home. (Code Sec. 121(a)) specifies:
Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more.
For instance, if a person anticipate selling his home soon, the timing can be critical to the amount of gain he or she may exclude from income. Qualifying taxpayers may exclude up to $250,000 of gain on the sale of a principal residence, $500,000 for a joint return. (Code Sec. 121(b)(2)(A)). However, if a taxpayer meets all the requirements and sell his home within two years of his spouse's date of death, he may still take the full $500,000 exclusion, as if he or she is still married. To claim this exclusion, he must own and occupy the property as a principal residence for two of the five years anterior to the sale. If he owns more than one residence, his principal residence is the home he uses most of the time during the year.
Generally, married couples may exclude the gain from the sale of a principal residence if:
1. Either spouse owned the property for at least two of the five preceding years;
2. Both spouses used the property for at least two of the five preceding years as a principal residence; and
3. Neither spouse used exclusion within the preceding two years.
The first two requirements do not have to be satisfied during the same time. A residence can be a house, houseboat, mobile home, cooperative apartment, or a condominium. If this taxpayer remains unmarried and if the requirements were met before his or her spouse's date of death, he or she may exclude $500,000 of gain on the sale of his or her home. However, the sale must not occur later than 2 years after the date of death.
Tax planning opportunities also exists for properties used as investments. Regulations do not require a property to be a principal residence on the sale date; however, at the time of the exchange, if the property is an investment property owner may exclude gain on sale as a principal residence, provided he meets the ownership and uses to test. A person may also be able to defer any remaining gain in a like-kind exchange. An individual may want to review these options more carefully, especially if deliberating selling a home, or even if he or she is contemplating investing in a vacation home, because many home ownership tax benefits also apply to a second home.