Federal capital gains exemption for the sale of your home
The 1997 Budget Bill and Tax Amendments provided substantial capital gain income tax relief to taxpayers who have sold their home. Just as in the prior rules, the home being sold must be the taxpayer’s principal residence.
However, the 1997 capital gains exclusion is much more generous for most taxpayers. Under these rules a couple can exclude taxes on up to $500,000 in profit on the sale of their home. Single taxpayers may exclude up to $250,000 in profit. The exclusion is no longer limited to older taxpayers. Anyone who owns their home for two of the past five years qualifies for the entire exemption, and if you live in the home for a shorter period, a pro rata amount can still be excluded. Moreover, there is no limit on the number of times the exclusion can be used as long as the sale is of a residence.
With these rules, however, the former exclusion by rolling over profits into a new home is gone. This will matter most to long time property owners who have rolled over profits when purchasing bigger and bigger homes. If the current house sale will result in some tax liability because you have profits in excess of the new maximums, you can no longer avoid the tax by buying another house.
What exactly is capital gain? The capital gains tax exclusion is an exclusion of the profit you made on selling your home. To calculate the profit, you take the "basis" -- that is what you paid for the house originally plus improvements that you paid for that increase the house's value -- and subtract it from the selling price. The difference is your gain or profit. If you owned your home for a number of years it is likely that the sale price is more than the combination of purchase price plus improvements. If the gain is less than the exclusion there is no tax.
As an example, let’s say you are single and your basis in your home is $50,000, a combination of the $20,000 purchase price and $30,000 for improvements over the years. If you sell the house today for $125,000, you have a capital gain of $75,000. Since this is less than $250,000 (the exclusion allowed for a single person) you would not pay any capital gains income tax.
