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Fine-Tuning the Home-Sale Tax Breaks


WASHINGTON — The rules that govern whether--and how much--millions of Americans have to pay in federal taxes on their home sale profits are under the microscope at the IRS.

Tops on the list for clarification: How can people who've owned their homes for short periods of time--less than the two-year statutory minimum--qualify for a piece of the $250,000 and $500,000 tax-free exclusions when they sell?

How can they qualify for tax relief when they're forced to sell earlier than they planned because of "unforeseen circumstances"?

And should private and government employees who are transferred abroad by their companies or agencies for extended periods be penalized by the tax code when they return and sell their homes for a profit?

Issues like these dominated a key hearing last week on the IRS' proposed regulations governing capital gains taxation for all home sale profits. Under congressional reform legislation enacted in 1997 and 1998, a homeowner can exclude up to $250,000 (single filer) or up to $500,000 (if filing jointly) of profits on the sale of a house, provided it was owned and used as a principal residence for at least two of the five years preceding the sale.

Under the law, taxpayers who sell before the minimum two-year period because of a change in place of employment, health, or unforeseen circumstances may be eligible for a reduced tax-free exclusion. For instance, a new homeowner who suffers a serious health problem requiring hospitalization could qualify for a fraction of the maximum tax-free exclusion. If he or she had owned the property for a year before the sale, the taxpayer could qualify for half of the maximum $250,000 tax-free exclusion, since ownership and use totaled half of the two-year requirement. An 18-month ownership period would qualify for three-fourths of the maximum $250,000 exclusion.

Vague Wording Merits Explanation

Health and employment changes are relatively straightforward under the law, but what did Congress really mean by "unforeseen circumstances" as a qualifier for tax relief? Should this vague wording allow anyone who sells before two years to conjure up an "unforeseen" compelling reason to claim a piece of the $250,000/$500,000 tax-free write-off?

Should you, for example, qualify for the tax break when you sell a year after your home purchase because the neighbors next door turned out to be noisy or rude? What if you don't like the neighborhood, the planes flying low, the quality of the local schools? Are these unforeseen circumstances good enough to get you a tax break?

Representatives of accounting and real estate professional groups urged the IRS to take a middle road in answering these questions. On the one hand, they said, the IRS should provide taxpayers with concrete examples of situations that would qualify as unforeseen and deserving of tax savings. On the other hand, though, the IRS shouldn't open the door to just any hoked-up excuse for selling early by home buyers who have remorse about their purchase.

What should the standard categories of legitimate unforeseen circumstances be? The National Assn. of Realtors and the American Institute of Certified Public Accountants (AICPA) asked the IRS to adopt these, among others:

* Divorce or legal separation--unforeseen by the homeowners in most instances, but not addressed in the statute.

* Death of a spouse, family member or co-owner.

* A change in the health of a family member who is not an owner of the property and doesn't necessarily even live in it. Though the statute gives a break when an owner's health situation changes, a "change in the health of a family member can also be a compelling reason to sell a home," said Toby Bradley, chairwoman of the realty association's federal tax committee. "An individual might have to sell . . . in order to care for a family member elsewhere," she said.

* Financial hardships that affect the owners' ability to keep paying for the house. For example, said Ronald Hegt of the AICPA, an adult child living with his parents in their home and contributing to its costs could trigger an unforeseen financial crisis for the homeowners if he lost his job.

What of Homeowners Transferred Abroad?

A second issue the IRS was asked to grapple with concerns homeowners who are transferred abroad by employers for extended periods, and then return and want to sell. Under the IRS' proposed regulations, their time abroad does not count toward the minimum two-year ownership and use test because they are not physically occupying the property. But Peter Scott of the Employee Relocation Council argued that this is unfair and costly, especially when the owners continue to pay the mortgage, taxes and own the house in all respects other than occupying it.

The IRS gave no hint on how it would handle issues like this in its final rules expected later this year. But you can bet a number of the suggestions for improving the rules will end up in the final version. Stay tuned.


Distributed by the Washington Post Writers Group.

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