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Christopher Phelps
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience:  CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
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Capital gains tax

Customer Question

I am selling a home that is worth more than the home I am buying. I was forced to go into a smaller house becuase my wife and i just couldn't afford the payments. Do i still have to pay capital gains tax on the property worth more?
Submitted: 11 years ago.
Category: Tax
Expert:  Christopher Phelps replied 11 years ago.

You may no longer rollover your gain on the sale of your principal residence to your new residence under former IRC Sec. 1034. Instead, in 1997 the Congress replaced the rollover provisions with a capped exclusion that you may use once every two years under IRC Sec. 121. A partial exclusion is available under some circumstances if you are unable to meet the two year requirements.


Under IRC Sec. 121 if as of the date of sale you have owned and used a property as your principal residence for 24 out of the last 60 months, then you can exclude up to $250,000 of gain ($500,000 if married filing joint) if filing a single or MFS return.


If you have owned or used your property as your principal residence for less then 24 months you may not use the Sec. 121 exclusion (i.e. $250K/$500K exclusion) unless you meet a qualified exception. You may use a pro-rata exclusion if the reason you are selling is related to a job change, for medical reasons or for some other unforeseen circumstance (i.e. death, disability, divorce, job loss, financial hardship, etc.).


The pro-rata portion of the exclusion is calculated by dividing the number of days you both owned and occupied the property as your principal residence by 730 days (i.e. two years). Multiply the resulting percentage by $250K if single or $500K if MFJ.


If you do not meet one of the exceptions, then the gain is taxable. Also, if your gain is in excess of the available exclusion amount, then the excess gain is taxable. If you own the property for more then one year, then the gain will be treated as a long-term taxed up to a maximum capital gain rate of 15% (5% if the gain would otherwise be taxable in the 10% and 15% brackets). Otherwise the gain is treated as a short-term capital gain and to the extent not offset by other capital losses will be considered as ordinary income the same as wages and interest subject to whatever your marginal tax rate is.


Most states have conformed to the Federal law described above. Accordingly, the manner in which your gain on the sale of your principal residence is treated for Federal purposes will also likely be the same for your resident state tax purposes as well. If you indicate what your resident state is I can confirm this for you.


Based on the facts you indicate you may be eligible for a pro-rata exclusion (assuming you do not meet the two year requirements) based on unforeseen circumstances related to your financial situation. A sale or exchange is due to unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer could not reasonably have anticipated before purchasing and occupying the residence. Under the safe harbor rules, a sale or exchange is deemed to due to unforeseen circumstances if any of the following events occur during the period of the taxpayer's ownership and use as principal residence; in the case of a qualified individual, death, the cessation of employment if, as a result, the qualified individual is eligible for unemployment compensation, a change in employment or self-employment status that results in the taxpayer's inability to pay housing costs and reasonable basic living expenses for the taxpayer's household, divorce or legal separation, or multiple births resulting from the same pregnancy.


The unforeseen circumstance exception is rather open-ended and is subject to the taxpayers facts and circumstances. If none of the above exceptions applies, give me some more detail about the reasons for the sale and I can then give you my opinion about whether a pro-rata exclusion may be available.


Because it is impossible for me to identify and consider ALL the relevant facts, this advice is not intended or written to be used for the purpose of avoiding penalties, and cannot be used for that purpose.

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