One item that individuals must consider when selling their home is whether or not they will need to pay any capital gains taxes on the sale of their residence if the selling price is more than the original purchase price. The difference is referred to as capital gain. For a number of years, individuals have been able to exclude up to $250,000 of the gain (or $500,000 for couples filing joint returns) on the sale of their home.
Certain qualifications must be satisfied in order to utilize this capital gain exclusion. These qualifications include the seller has owned and used the home for at least two years during the previous five years. That five-year period ends on the date of the sale. If an individual does not qualify for this capital gain exclusion, then the gain is usually treated as long-term capital gain and taxed at a rate of up 20% of the gain.
If a husband and wife own the residence, then either spouse can satisfy the two-year ownership requirement, but both spouses must satisfy the two-year principal residence requirement in order to exclude $500,000 of gain. Also, neither spouse may have used this provision within the last two years prior to the sale. If either spouse fails these requirements, then the gain exclusion may be limited to only one spouse’s $250,000.
Here is an example of how this situation works. Sally and Joe, who are married file a joint income tax return, purchased their residence in 2007 for $200,000. In 2011, they receive an offer to sell their residence for $350,000 since their location has become very valuable in the last four years. Assuming that they satisfy the ownership requirements, they would be entitled to exclude the entire amount of gain ($150,000) because the gain does not exceed $500,000. This would potentially save them $30,000.
This situation becomes more complicated when a parent transfers their home to a child in order to protect it in case the parent later has to enter a nursing home. If an individual does this and the child then sells the home without having lived in the residence, then the child will pay capital gains tax if the sales price is greater than the amount paid by the parent when he or she originally purchased the home. If the parent would have retained the home, passed it to their child at death, and then the child sells the home, there would not have been any capital gains tax to pay. If we knew that the parent was going to go to the nursing home, then the parent should transfer the home to the child at least 5 years before that happens and approximately 80% of the value of the home will be protected. However, it the parent does not ever enter a nursing home, the child would have been able to keep 100% of the house proceeds if he would have inherited the home from parent. Individuals always want to discuss whether or not to transfer their home in order to protect it from any future nursing home costs; however, the decision becomes much more complex when considering this potential capital gains tax. If I could only predict the future, I could be much more beneficial to my clients.
Each person’s situation is different so it is very important to consult your estate planning attorney when considering whether to transfer the ownership of your home to your children.
NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.
James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway
New Philadelphia, Ohio 44663