They represent just four easy-to-miss little items in a behemoth 700-page tax bill now heading for House action. But if you're one of the estimated thousands of homeowners that the tax code changes will probably affect every year, they could prove highly significant.
You could be one of those if you:
- Expect to use the $125,000 tax-free exclusion for capital gains on your home sale profits after age 55.
- Maintain an office in your home and take depreciation deductions annually on the office space.
- Rent out your home for a couple of weeks and hope to keep the rental income tax-free.
- Want to make efficient use of the standard tax-deferral "rollover" rules for home sale profits after a divorce or separation.
Here's what the new legislation sponsored by House Ways and Means Committee Chairman Rep. Bill Archer (R-Tex.) would do if approved by the House and Senate. Final action is expected in October.
Under current law, you can lop off up to $125,000 of the capital gain on the sale of your home and exclude it from taxation. To qualify you must have reached the age of 55 before the date of the sale and used the home as your principal residence for at least three of the five years before the sale. You get this windfall just once in a lifetime.
But there's a glitch in the law. If you and your spouse take the exclusion, that's it. If through divorce or the death of your spouse, you find yourself single again and then remarry, you could inadvertently disqualify your new spouse from his or her own $125,000 exclusion. That's because under current law, husbands or wives who have already used the exclusion are what some tax specialists call "tainted spouses." They carry the tax code equivalent of a genetic defect that can be transmitted to a new spouse.
Say you bought a home two decades ago for $100,000 with your late husband. The house is now worth $400,000. You plan to remarry and your intended new spouse is 58 and recently divorced. Before the divorce, he and his former wife took the $125,000 when they sold their home.
Here's the glitch: If you marry him and you both live in your present home, you could lose the tax right to take the $125,000 exclusion on the property for as long as you're married to him. Of course, you have a prenuptial strategic option: You could sell your home and take the $125,000 exclusion on the $300,000 gain before heading to the altar.
But why should you have to? That's the point of the House's new tax bill. It would allow you or any otherwise qualified taxpayer to take your exclusion provided you owned your home for at least three years before marrying, even if the new spouse had already made use of the exclusion.
Another item of note in the new bill: If you have an office in your home and you depreciate it, you've got to take special care when you sell the home and roll over the tax-deferred gain into a new, more costly home. To the extent that you've already depreciated your office space for federal tax purposes, you can't roll over that amount of gain.
Say you've taken $5,000 worth of depreciation over the years on your home office. You sell your house at a $100,000 gain, but defer tax recognition of the gain by buying a more costly home. Under the new bill, you could roll over only $95,000 of your gain. The remaining $5,000 would be subject to regular income taxation in the year of sale.
Tax specialists such as attorney Stefan F. Tucker of Washington, D.C., say people who operate businesses out of their homes often have "simply ignored the fact that they've taken depreciation" on office space when it comes time to sell their principal residence. The new bill would force them to pay strict attention to that detail.
Two other easy-to-miss items in the bill that could touch you in the coming years:
- Closing the loophole that allows homeowners to rent their dwellings up to 14 days a year and pocket the cash tax-free.
- Eliminating the capital gains rollover anomaly that forces some divorcing spouses to live in the same house, even if they prefer living apart. To qualify for tax-deferral rollover on the gain from a home sale, the house has to be your principal residence. But that may not be the case if you've been living somewhere else for an extended period. The new bill would create a safe harbor for spouses heading their separate ways.
Either spouse could treat a home as his or her principal residence at the time of sale if the house was sold pursuant to a divorce or separation and if the taxpayer used the house as a principal residence any time during the prior two years.
The bottom line: If living at home with the spouse you plan to divorce is hell, then cheer up and move out. Tax help may be on the way from Congress.
Distributed by the Washington Post Writers Group.