Capital Gains Tax On Real Estate Sale - How to and When… ?

November 29, 2004
By Payal Pathak

Mike and Dorothy owned and occupied their principal residence in any two out of five years. They wanted to sell them and there by go ahead with capital gains tax on real estate sale on up to $500K of the gain. They could envision a scenario where they could have had two principal residences at the end of a five year period. But the problem lied with that they wanted to sell both of them at them at the same time and take $500 tax exclusion on each.

The US law restricts the use of the exclusion to once every two years. Even though they could have had two homes meet the two out of five year ownership and residency test, they couldn't sell them both and exclude gain on both in the same year. They would have to wait at least two years after the sale of one home to which the exclusion applies before selling the second. This way they could avoid paying capital gains taxes on sale of their real estate.

An exception allows use of part of the $500,000 exclusion if the second real estate is sold in connection with a change of employment (a new job, for example) or health (having to move into an assisted living center, for example).

The restriction and the exceptions to it are presented in IRS Regulations 1.121-2(c) and 1.121-3.

Also with respect to a partial credit of the exclusion, the regulations don't specifically address whether selling because of retirement would qualify for an exception to 2 out of 5 year rule. The regulations refer not to a job change but to a "change in place of employment."

The IRS also states that retirement does not qualify as "change in place of employment." This means that in order to avoid the capital gains tax Mike and Dorothy would have to wait for two years before taking the benefits of exclusion rules for their homes.