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Gain On The Sale Of Taxpayer Residence

Federal Tax Course – Lesson 19

Introduction – Reason for the Special Provisions 1901
Gains on Sales or Exchanges Before May 7, 1997 1902
Nonrecognition of Gain (Section 1034) 1903
How the Sec. 1034 Gain is Reported 1904
Exclusion of Gain by Taxpayers 55 and Over (Section 121) 1905
Gains on Sales or Exchanges After May 6, 1997 1906
Reduced Exclusion 1907
Transitional Rules 1908

 Reason for special provisions regarding the gain on the sale of a taxpayer’s principal residence

This assignment discusses important relief provisions which were enacted to reduce or eliminate the tax that would otherwise be payable where a taxpayer sells his home at a profit.

A homeowner who for one reason or another decides, or is forced, to sell his residence will frequently realize a substantial capital gain upon selling his old home — especially if he has owned the home for a long time.  Yet, if he purchases or builds a new home at today’s inflated prices he will usually wind up with little, if any, net gain, because he will have to reinvest all or most of the proceeds in his new residence.  Nevertheless, under the normal tax rules the individual would have to pay tax on the sale of his old residence in spite of the fact that he realized no (or little) actual economic benefit.

To alleviate this problem, special relief provisions have been in place for many years, under which all or part of such gains were deferred (for taxpayers under 55 at time of sale) or completely excluded (for taxpayers 55 or older).

The Taxpayer Relief Act of 1997 completely overhauled the rules and substantially expanded the tax savings provided.  Generally, the new provisions apply to home sales (or exchanges) after May 6, 1997, while pre-May 7th sales are subject to the old rules.

Either way, tax-favored treatment applies only to gains on taxpayer’s principal residence.  The term, “principal residence” includes a houseboat, house trailer, condominium or an apartment that taxpayer owns in a cooperative apartment house, so long as it is actually used by the taxpayer as his principal residence.  Thus, a summer home, vacation bungalow, etc. will not qualify.  The purchase of an accommodation in a retirement home is also not considered the purchase of a new residence.

Where a house is used partly as taxpayer’s principal residence and partly rented or used for business purposes, only the portion used as residence qualifies for non-recognition of gain or the exclusion.  In this case, the property is treated as if it consisted of two separate houses or properties and the gain or loss is computed separately on each as illustrated in Assignment 7.  In most cases the apportionment between the residential and non-residential part is made on the basis of comparative fair market value.

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