Generally, taxpayers may exclude up to $250,000 of gain on a principal residence every two years. Husbands and wives who file a joint return for the year of sale may exclude up to $500,000 of gain on the sale of a principal residence if one of the spouses owned the residence for at least two years and both spouses resided in the premises as their personal residence for at least two years.
Starting in 2008, the law was modified in situations involving a surviving spouse of a decedent. Under previous law, the surviving spouse could only exclude up to $500,000 if he/she sold the residence before the end of the year in which the spouse died. As of January 1, 2008, the sale of a residence that had been either jointly owned, or owned by one of the spouses, and occupied by the surviving and deceased spouse, is entitled to the $500,000 gain exclusion, provided the sale occurs no later than two years after the date of death of a spouse.
In the case of a jointly-owned residence, the surviving spouse continues to be allowed a step-up in basis in the residence for the deceased spouse’s one-half share. The $500,000 exclusion is a benefit for surviving spouses that is in addition to the step-up in basis for the decedent’s half of the property. As a result, a significant amount, if not all, of the sale price could be free of any income tax.
In 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act. This Act excludes from gross income amounts attributable to a discharge of indebtedness after 2006 and before 2010 incurred to acquire a principal residence. This Act does not apply to vacation homes or other kinds of secondary residences. It basically means that if a taxpayer’s residence is foreclosed on and the bank sold the property at auction and realizes only a portion of the debt owed, any excess amount owed by the taxpayer that is forgiven by the bank is not includable in the taxpayer’s income for tax purposes.
There are several other details and rules governing various issues in this area of the law. If you have a question or are attempting to develop a strategy for the sale of your principal residence, and even vacant land adjacent to a residence, please contact us at 271-4500.