By: Justin M. Kennedy, Attorney
Law Office of Roy W. Litherland
I spoke with a client, William, the other day who shared that he purchased his home many years ago for fifty thousand dollars ($50,000). That same home is now worth an estimated one and a half million dollars ($1,500,000). If the home was sold today, the capital gains taxes would be calculated on the difference between the sale price ($1,500,000) and the basis in the property ($50,000), for a taxable gain of $1,450,000. At the 20% long-term capital gains tax rate, that $1,450,000 taxable gain would result in William owing $290,000 in taxes.
If we were talking about stock rather than the home, the tax conversation would have ended there. However, built into the Internal Revenue Code (in Section 121) is a special exclusion of gains from the sale of a personal residence. To qualify for this exclusion, during the five (5) year period preceding the sale, the property had to be owned and used by the taxpayer as the taxpayer’s principal residence for at least two (2) years.
If William qualifies for the exclusion, it reduces his taxable gain by $250,000. That means rather than being taxed on $1,450,000 of gain, he would only be taxed on $1,200,000. This exclusion would reduce his taxes from $290,000 to $240,000, a $50,000 tax savings.
William had lived in the home as his personal residence since he first bought it. Unfortunately, almost three (3) years ago, his health declined to the point that he was no longer able to take care of himself at home and he needed to move into a skilled nursing facility. As his time at the facility approached the 3-year point, he began to worry that if he did not immediately sell the house, he would lose his $250,000 personal residence exclusion.
I thanked William for sharing his concern and then I explained a less well-known provision of Section 121, specifically paragraph (d)(7). Section 121(d)(7) provides that in the case of a taxpayer who is physically (or mentally) incapable of self-care and resides in a nursing home, if the taxpayer owned and used the property as the personal residence for at least one (1) of the last 5 years, then the taxpayer would qualify for the $250,000 personal residence exclusion.
In this case, William would be able to qualify for the $250,000 personal residence exclusion for an additional year. William expressed relief that he did not need to immediately sell his home to keep the $250,000 personal residence exclusion and instead he could weigh his options for an additional year.
There are many aspects to consider when deciding whether to sell a home, but for those who move to a facility, we hope that qualifying for an extra year of the $250,000 personal residence exclusion will provide some peace of mind.
IRS CIRCULAR 230 NOTICE: Any tax advice contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. If you would like to receive written advice in a format that complies with IRS rules and that may be relied upon to avoid penalties, please contact the law office.