The law authorizes a special break for home sellers. They can “exclude”—that is, “escape”—taxes on as much as $500,000 in profit for married couples filing jointly and $250,000 for those who file singly or are married and file separate returns. Remember, that’s profit, not sales price. What if the profit is greater than the exclusion amount of $250,000 or $500,000? The excess is taxed as a long-term capital gain at a maximum rate of 15 percent, plus applicable state taxes.
The exclusion is not a one-time opportunity. Claim it as often as every two years. To qualify, you must pass two tests. First, you have owned and lived in the property as your principal residence or main home for at least two years out of the five-year period that ends on the date of sale. Second, you have not excluded gain on another sale of a principal residence within the two years that precede the sale date. Those two years need not be consecutive; they can be off and on for a total of two full years. Short, temporary absences for vacations or other seasonal absences count as periods of owner use. This holds true even if you rent out the property during the absences.
The Internal Revenue Service figures the ownership and use tests separately. Under this pro-taxpayer approach, the exclusion is available when, for example, an apartment dweller buys her apartment after the building goes condominium and moves elsewhere before she sells the apartment. The law does not require her to own and use the dwelling simultaneously for at least two years. For exclusion purposes, the period of apartment use and condominium ownership need not involve the identical period of years.
There is tax relief in the form of a partial exclusion for someone who sold another home within the previous two years or fails to satisfy the ownership and use requirements. Take advantage of the partial exclusion when the primary reason for the sale is health problems, a change in employment or certain unforeseen circumstances. These include divorce or legal separation, or natural or man-made disasters that cause residential damage. To illustrate: you are single, have lived in your dwelling for just 12 months and move to a new job in another city. You can exclude gain of as much as $125,000—12 months divided by 24 months, or 50 percent times $250,000.
A key requirement for tax-free profits is that the dwelling is owned and occupied by you as your principal residence, IRS-speak for the place where you live most of the year, as opposed to a vacation dwelling or property for which you charge rent. The profit exclusion is not limited to the sale of a conventional single-family home. Your principal residence also can be a condo, a cooperative apartment, your portion of a multiunit apartment building, a house trailer, a mobile home or anything else that provides all the amenities of a home, such as a houseboat or yacht that has facilities for cooking, sleeping and sanitation, or even a vacation retreat that you move into after retirement. Moreover, the location of the principal residence does not matter. It can be in a country other than the United States.
How to Avoid Taxes on Your Life Insurance Policy
You can structure your life insurance policy in a way that would eliminate estate taxes on its death benefits. Life insurance death benefits generally are not subject to income taxes. However, if the deceased insured owns the policy, they are subject to estate taxes. One way the policy’s beneficiaries would avoid income and estate taxes is if the policy was purchased by an irrevocable trust. An irrevocable trust is a trust that cannot be annulled by the grantor (the person who originally set up the trust). If you have an existing policy on your life, it may be prudent to transfer it to an irrevocable trust. As long as you survive more than three years from the date of transfer, your survivors can receive the death benefits free of both income and estate taxes.
–Ryan Mack, president,
Optimum Capital Management L.L.C.