Capital Gains and Future Profit

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New Rules for Capital Gains

Since 1977, the tax laws have allowed home owners to sell their main residence as long as they have lived there for two of the five years leading up to the sale and keep a huge chunk of the profit tax-free. Married couples can rack up as much as $500,000 tax-free while singles get up to $250,000. It does not matter if you sell the house and move into a more expensive mansion or a less expensive cottage or even a rental apartment. You could even pitch a tent in the woods and call that home. The profit is yours – tax-free. And you can take advantage of this wonderful tax break as often as once every two years. But the old tax rules were in effect for many, many years and they still linger in the back of the minds of many people. It used to be that the only way to shield your capital gain from a home sale was to buy a more expensive home and roll your profit over into that. Its only once in a lifetime that you could downsize to a smaller home and shield some of the profit from taxes. The old law put an awful lot of pressure on people approaching or in the early years of retirement. You had one change to downsize and you did not want to do it prematurely and then face a big tax bill if you needed to move to an even less expensive home or rental sometime later. Rest assured the old law is dead. The tax collector has very little say now in how expensive your next home must be.

Want To Preserve Future Profit? Move In Now

Half a million dollars in home-sale profit is not the huge sum it used to be because of the run-up in housing values in recent years. If you have been a homeowner for many years and under the old tax rules, you rolled your profit over from previous home sales into your current home, you might want to look at selling just to preserve future home appreciation from taxes.

Here’s how it works: Let’s say you owned a couple of homes before the tax laws changed in 1997. If we look back, it’s amazing how little you paid for your very first home. Over the years, property values rose steadily and you ended up with $250,000 of capital gains or profit from all your previous sales. Back in 1996 or earlier, when you bought your current home, the tax laws dictated that you roll that profit over into the new one. You do that with a process called adjusting your basis. Let’s take a closer look at that example. Say you paid $500,000 for your wonderful home in 1996, before the new tax rule took effect. To make it simple let’s just say you bought it without any down payment. You had to roll over your $250,000 from the sale of your old home into the new home for tax purposes. On paper, you reduced the investment in your new home by that $250,000 profit you racked up from various home sales over the years. Because you shrunk the cost of your new home ($500,000 minus $250,000) you have what’s called an ‘adjusted basis’ of $250,000. As a result, you will reap a bigger profit – at least on paper – when you sell.

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