By Broderick Perkins
DeadlineNews.Com

WHEN the 105th Congress passed H.R. 2014, the federal Taxpayer Relief Act of 1997, home owners breathed a sigh of relief, but three years later the sighs more often revealed exasperation over several misunderstood provisions.

The three year old federal tax law says when you sell your home, if you qualify, you can keep, tax free, capital gains of up to $500,000 if you are married filing jointly or $250,000 for single taxpayers, or married taxpayers who file separately.

"The biggest confusion is that many people think that the $500,000 applies to everyone. It only applies to couples who file joint returns. It comes as a big shock that you only get the $250,000 exclusion if you are single or filing separately," said Leonard L. Williams a Sunnyvale, CA certified public accountant.

Under the law, to qualify for the $500,000/$250,000 exclusion, the home must have been your primary residence for at least two of the prior five years.

That has two implications.

Residency, use requirements

First, the two-year primary-residence-use requirement doesn't mean you must physically occupy your home every day for 720 days.

If you are away on a business trip or on an around the world cruise for several months, or otherwise not physically living in your primary residence for relatively short periods, that doesn't interrupt you from meeting the two year requirement.

"So long as the home is still your primary residence, being away doesn't take away from counting toward the two years," says personal finance advisor Eric Tyson, author of "Personal Finance for Dummies" (IDG Books, $19.99).

If you've met the two year requirement and for whatever reason must leave it vacant for extended periods, to retain the exclusion you'll have to sell it within the allotted five year period, or after five years are up, move back in to reestablish the two year requirement.

"The fact that you may be away from it for up to three of the last five years is the only allowance that the Internal Revenue Code gives you for temporary absences," said Williams.

Second, rental homes

In another twist, if you have a second home where you live, go to work, send the kids to school or otherwise treat as your primary residence, say every other year, it will take you four years to qualify either or both homes.

"Theoretically, you have qualified both homes to exclude taxes on the gain, but you can only take one and wait another two years before you can take the other," said Marie Sternberger, an enrolled agent in Sunnyvale, CA.

The liberal law not only says you can take the exclusion on one home every two years, it also says you can take it as often as you meet the qualifications.

"That makes the law a good tax planning tool," says Sternberger.

For example, if you have a rental property you move into after selling your first home and taking the exclusion, two years later, you can also exclude taxes on the gain from the rental-turned-primary residence. You'll have to recapture any depreciation (depreciation is taxed at a federal tax rate of 25 percent) on the rental.

Two-year requirement loophole

A related law also makes provisions for you if, through some unforeseen event, such as a job change, illness or some other hardship, you are forced to sell before you meet the two-year residency requirement.

The federal Internal Revenue Service Restructuring and Reform Act of 1998 says you can prorate the $500,000/$250,000 exclusion (not your specific gain) if you are forced to sell early.

That means if you only live in your home a year before you are forced to sell, you can exclude from taxes up to $250,000 in capital gains if you are married and file jointly or $125,000 for separate and single filers.

Old laws erased, not deferred gain

Finally, the tax relief act also removed from the books the $125,000 tax exclusion on capital gains for home owners older than 55 and the "rollover" law that allowed you to defer paying your taxes provided you purchased another, more expensive home. Those laws are history.

However, any capital gain taxes deferred before the tax relief act are unpaid taxes that must be accounted for.

"Previously deferred gain reduces the cost basis on your next home. If you have a deferred gain of $100,000 and buy a home for $250,000 your cost basis (against which you will figure capital gains when you sell it) is $150,000," said Sternberger.

By Broderick Perkins
DeadlineNews.Com

More than half a decade after U.S. Congress passed the federal Taxpayer Relief Act of 1997, the Internal Revenue Service is still tinkering with its provisions.

The latest adjustment, which, clarifies how to define the nagging "unforeseen circumstances" provision, warrants a reexamination of the tax relief act to fully understand the adjustment's significance.

The Taxpayer Relief Act of 1997 is the federal tax law that says when you sell your home you can keep, tax free, capital gains -- profits -- of up to $500,000 if you are married filing jointly. The tax exclusion is on capital gains of up to $250,000 for single taxpayers or married taxpayers who file separately.

The exclusion is available when you sell your home if the property has been your primary residence for at least two years during a five-year period ending on the date of the sale.

The new law did away with two previous capital gains tax laws.

"There's no longer any such thing as a tax deferral through the sale and replacement of a personal residence (known as the capital gains "rollover" law), and hasn't been since 1997. Many people still haven't gotten this message," said Leonard W. Williams, a certified public accountant in Sunnyvale.

Along with removing the "rollover" provision, the tax relief act also removed from the books the $125,000 tax exclusion on capital gains for home owners older than 55.

The current Taxpayer Relief Act of 1997 does provide for a prorated exclusion available because of unexpected job changes, health problems or other "unforeseen circumstances" that force you to sell your home before you reach the two-year milestone.

The amount prorated is the exclusion, not the specific gain. For example, if you only live in your home for year before you are forced to sell, you can exclude from taxes up to $250,000 in capital gains if you are married and file jointly; $125,000 for separate and single filers.

However, what specifically constituted an "unforeseen circumstances" was left to the interpretation of tax payers, tax professionals and even the IRS.

The latest adjustment better defines "unforeseen circumstances" by addressing how to define it.

"The final regulations narrow the definition (of 'unforeseen circumstances') from 'an event that the taxpayer did not anticipate' to 'an event that the taxpayer could not have reasonably anticipated' prior to purchasing and occupying the residence," said Marie Sternberger, an enrolled agent from Sunnyvale who specializes in taxation matters.

"The final regulations did not include marriage or the adoption of a family member as additional unforeseen circumstances because, according to IRS, marriage and adoption are voluntary events that are not unforeseeable," Sternberger added.

Likewise a sale that is only beneficial to the general health or well-being of the home owner won't qualify for the tax break.

The new rules still allow taxpayers to make a case for "unforeseen circumstances," but also gives specific guidelines for acceptable incidents of "unforeseen circumstances," including:

• The "involuntary conversion" of your home, say, when the state government or other eminent domain order requires you to sell your house to make way for a new highway.

• Natural or man-made disasters or acts of war or terror that damage the residence.

• The death of the homeowner, a spouse, co-owner or other person whose principal place of residence is the house that was sold.

• Health problems, if the primary reason for the sale is "to obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury" of the home owner, co-owner, spouse or other resident.

• A loss of employment triggering eligibility for unemployment compensation.

• A change in employment status that results in the owner's inability to pay housing costs and reasonable basic living expenses.

• Divorce or legal separation.

• Multiple births resulting from the same pregnancy.

Also military personnel posted abroad for extended periods can now stop the clock on the two-of-the-past-five-years provision until they return stateside.

"It seems to me that IRS is tightening the 'unforeseen circumstances' provision and making it harder to qualify under these regulations," said Sternberger.

by Broderick Perkins
DeadlineNews.Com

WHEN the Internal Revenue Service published guidance about capital gains tax exclusions on the sale of your home, giving millions of home sellers an early Christmas present, it also sent a little package of cheer to home-based business owners who sell their home.

As long as your qualified home-based business is in the same dwelling as your primary residence -- rather than some unattached structure on your property -- you don't have to allocate a home sale's capital gains between the home and the business, according to "Exclusion Of Gain From Sale Or Exchange Of A Principal Residence," U.S. Department of Treasure Decision 9030, published Dec. 24, 2002 in the Federal Register, Vol. 67, No. 247.

The provision is among the latest round of Congressional tinkering with the Taxpayer Relief Act of 1997. Law makers have been adjusting the landmark tax package since it was enacted more than a half decade ago.

Among numerous provisions, home sellers have most enjoyed the provision that says when you sell your home, up to $500,000 of capital gains is excluded from federal taxes for married couples who file a joint tax return. Up to $250,000 is excluded for those filing separate or single-filer returns. To qualify for the exclusion when you sell your home, you must have lived in your home as your primary residence for two of the past five years.

The tax relief law, which applies to sales made after May 6, 1997, also said if you qualify for and take the home-office deduction, that portion of your home designated as a work place was not eligible for the exclusion.

"If you used 10 percent of your home for a home-based business, 10 percent of the gain on the sale would be subject to capital gain taxes and you couldn't use the exclusion on that portion," said Marie Sternberger, an enrolled agent from Sunnyvale, CA.

That forced some home-based business owners to forego the home-based business deductions for two years in order to maintain the two-out-of-five primary residency requirements for the full capital gains tax exclusion.

How the law changed

That's no longer necessary.

Provided you meet the primary residency and other requirements, even if you operate a business from your home, you are entitled to the full tax exclusion on capital gains realized from the sale of your home, according to "IRS Issues Home Sale Exclusion Rules".

What's more, if you sold your home and were not able to take full advantage of the $500,000/$250,000 capital gains tax exclusion you can amend your tax return to do so. If you've already taken full advantage of the exclusion, it's not necessary to file an amended return.

There is a three-year statue of limitations on the amended return, meaning you likely can amend only the 1999, 2000 or 2001 returns.

"It's three years from the later of the due date of the return, including any extensions, or the date you actually filed," said Marie Sternberger, an enrolled agent in Sunnyvale, CA.

Don't forget, the Taxpayer Relief Act still requires that if you sell your home and you've taken a depreciation deduction, you still must recapture (or pay back) that depreciation at the rate of 25 percent. That's hasn't changed.

"It's (the new rule for home-based businesses) still a good deal, if you think about your tax reduction," said Sternberger.

Home-based business deductions (office, payroll, labor, auto, travel and entertainment expenses, business asset depreciation, supplies, items purchased for resale, etc.) reduce your net profit which in turn reduces your self-employment taxes and your income taxes.

"The home-office related tax reduction you are getting exceeds the 25 percent recapture amount," says Sternberger.

• Mortgage Insurance Tax Deductible In 2007

Your home is more than just a shelter from the elements.

It's also a tax shelter -- about a dozen times over.

Here's an introduction to the 12 most common federal tax breaks -- new and old -- you are likely to encounter as a homeowner.

Keep in mind, tax rules and regulations are often complicated, confusing and rarely easy to decipher. Chances are, you'll need professional help to make sure you benefit from as many tax breaks as possible. A tax pro can also help you with California's state tax rules which sometimes jibe with federal rules, but sometimes don't.

First, two terms you need to know.

Deduction -- A tax "deduction" reduces your taxable income. Less income to tax means less taxes to pay. For example, a $100 tax deduction reduces your $50,000 taxable income to $49,900.

Credit -- A tax "credit" is a dollar-for-dollar reduction in your actual taxes due. A $100 tax credit reduces your $1,000 tax bill to $900.

Two of the newest home-based tax breaks are available from the federal Mortgage Forgiveness Debt Relief Act of 2007.

1. Forgiveness of Debt Tax. In some cases, when a lender allows the homeowner to forego repayment of principal and or interest the borrower owes and discharges the debt, the debt is considered ordinary, taxable income. The new law allows certain taxpayers to exclude discharged debt from taxes, provided the lender discharges the debt in 2007, 2008 or 2009.

The amount of debt that can be excluded is limited to $2 million and the exclusion is only available for loans used to buy, build or substantially improve a principal residence. Vacation homes, investment properties and other second homes don't qualify.

"California does not conform to this new rule and you may still be subject to California taxes. It gets complicated," said Sam Kahn, an enrolled agent with Tax Reducers in San Jose.

2. Mortgage Insurance. The relief act also extends federal tax relief for qualified home owners who pay mortgage insurance. Qualified borrowers can deduct the full amount of their private or government mortgage insurance if their insured mortgage originates between 2007 and 2010. The initial one-year provision for the deduction was set to expire Dec. 31, 2007.

Those qualified are families with an adjusted gross income of $100,000 or less. Families with incomes up to $109,000 are eligible for a partial deduction.

"For people who can't get a mortgage without mortgage insurance, the fact that it is now deductible is wonderful," said Leon Sivils who is an enrolled agent and real estate agent with HomeAmerica.net in San Jose.

3. Energy Tax Credits. Another relatively new tax break was made possible by the Energy Policy Act of 2005. Tax credits of up to $500 are available for upgrading heating and air conditioning systems, insulation, windows, doors and thermostats, caulking, installing metal roofs and for otherwise putting the bite on energy waste. Qualified solar energy and fuel cell systems can net tax credits of up to $2,000. Related tax credits are also available for consumers who install clean-fuel vehicle refueling property at their principal residence.

4. Mortgage Loan Interest -- This is considered the Mother Of All Tax Breaks, because mortgage interest payments comprise a large portion of your mortgage payment in you loan term's early years. Mortgage interest is deductible on a maximum of $1 million in mortgage debt secured by a first and second home. The $1 million level applies to married tax filers who file jointly and single taxpayers. Married taxpayers who file separately split the maximum 50-50.

Kahn says, "The $1 million applies basically to the amount of the original purchase, plus any capital improvements. It's not just a blanket $1 million."

Home equity loan interest is also deductible, but limited to the smaller of $100,000 (half as much for each member of a married couple if they file separately), or the total of your home's fair market value as determined by a complicated formula. You'll really need professional help deciphering this one.

5. Home Improvement Loan Interest. The interest on a home improvement loan is also deductible, but calculated differently. You can deduct all the interest on a home improvement loan, provided the work is a "capital improvement" rather than repairs, or maintenance. Capital improvements typically increase your home's value (say, because you added a room), prolong it's life (a new roof) or adapt it to new uses (Universal design improvements to assist older people or people with disabilities). You can get tax benefits from repair work (painting, repairing, etc.), but only when you sell your home. However, you could use a home equity loan to make repairs and deduct the interest -- up to the available limits.

6. Points. Points, each equal to 1 percent of the loan principal, are charged by lenders as a loan cost on some loans. Refinanced mortgage points are deductible too, but only when they are amortized over the life of the loan. Once you refinance a second time, the balance of the old points from a refinanced loan offer an immediate write off, as you begin to amortize the new points.

"There's one booby trap here for the unwary. If you refinance through the same lender, then the remaining unamortized points on the existing loan can't be deducted as a lump sum if it is replaced with a new loan from the same lender," said Leonard Williams, a certified public accountant in Sunnyvale.

7. Property Taxes. Property taxes or real estate taxes are fully deductible. Any local, city or state property tax refunds reduces your federal property tax deduction by an equal amount.

8. Capital Gains Exclusion. Home buying investors' best tax shelter comes from provisions in the Taxpayer Relief Act of 1997 which allows married taxpayers who file jointly to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the prior five years. The amount is halved for those filing single or separately. The exclusion is available as often as you qualify (one home every two years) on an unlimited number of homes.

"The capital gains tax exclusion is huge around Silicon Valley," said Russell Barnett, an enrolled agent in San Jose.

Barnett says years of home price appreciation has piled on the gains for many homeowners. When it's time to sell, a half million in untaxed gain opens a lot of financial planning doors.

"Where else are you going to get tax free capital gain like that?" asked Barnett.

Kahn says the home can be owned by either spouse.

"It doesn't matter which spouse, as long as at least one spouse owns it," said Kahn.

9. Home-Based Business Deduction. Home-based business owners who use a percentage of their home exclusively for business can deduct the same percentage of certain home-related costs. Included are a percentage of insurance and repair costs, utility bills, improvements and depreciation. You may still have to face a recapture tax if you've taken a depreciation deduction because of the home-based business.

Kahn says, "You can also deduct a percentage of your mortgage interest and real estate taxes to reduce your self-employment tax as well as income tax and put the rest of your mortgage and property taxes on Schedule A."

10. Selling Costs and Capital Improvements. When you sell your home, you can reduce any taxable capital gain by the amount of your selling costs, which include real estate commissions, title insurance, legal fees, advertising and inspection fees. (Update: Costs typically stemming from decorating or repairs -- painting, wallpapering, planting flowers, maintenance, and the like -- WERE ONCE considered deductible selling costs if you completed them within 90 days of your sale, and completed them with the intention of making the home more saleable. The Taxpayer Relief Act of 1997 removed this deduction, according to Jesse Weller, an IRS spokesman in San Francisco. 3/4/08)

11. Moving Costs. A move triggered by a new job comes with some deductible moving costs. To qualify, you must meet certain requirements including, moving within one year of starting your new job, moving 50 miles farther from your old home than your old job was and working full-time at the new job for 39 of 52 weeks following the move. Deductions include travel or transportation costs and expenses for lodging and shipping an storing your household goods.

"The deduction for lodging doesn't include temporary housing but in transit housing plus one night at the new employment location," said Kahn.

12. Mortgage Tax Credit. Mortgage Credit Certificates (MCCs) allow qualifying low-income, first-time home buyers to take a mortgage interest tax credit of up to 20 percent (the amount varies by local jurisdiction) of the mortgage interest payments made on a home. This credit is available every year you keep the qualifying loan and live in the house purchased with the certificate. To benefit, you must enter your local MCC program and adhere to its guidelines.