Sale of residence--two-year rollover rules

This tax tip deals with the question of whether you can defer the tax on the sale of your residence when you buy a new one.

If you buy a new home within two years of selling your old home you won't have to pay tax on your gain on the sale unless the cost of the new home is less than the sale price of the old home. Many taxpayers are unaware of this part of the rule: if you don't pour all of the money from your old home into the new one, all or part of your gain does have to be reported. (Further, you can never recognize a loss on your home. Such losses are disallowed as "personal" unless you've converted the residence to income producing or investment use. If you expect a loss, I'd be happy to go over the opportunities with you.)

The key figure--the amount you must reinvest in a new home to avoid tax-- is the "adjusted sales price," or "ASP," of the old home. This is the "amount realized" on the sale, reduced by any qualifying "fix-up" costs. The amount realized is the sale price minus related expenses such as the broker's commission, advertising costs, and legal expenses in connection with the sale. "Fix-up" costs are limited to expenses for work performed within the 90-day period before the sales contract is entered into, if they are paid no later than 30 days after the actual sale date. Capital expenditures or improvements cannot be counted as fix-up costs.

Once you determine the ASP in this fashion, you can compare it to the cost of your new home (including related expenses). You will have to recognize gain on the old home to the extent the ASP on the old home is greater than the cost of the new home.

In determining your "realized" gain on the old home (as opposed to "recognized" gain (i.e., gain you must "report"), do not include the fix-up costs. Realized gain is just the amount realized (as defined above) minus your basis (original cost plus capital improvements). You will never have to recognize more gain than you realize. The following examples show how the rules work.

Example (1): Sally sells her old home for $300,000. The broker's commission was $15,000 and Sally incurred $5,000 of qualifying fix-up expenses. Her basis in her old home was $200,000. The new home cost $250,000.
Sally's "amount realized" on the sale of the old home was $285,000: the $300,000 sale price minus the $15,000 commission (ignore the fix-up costs for this purpose). Thus, she has "realized" gain of $85,000 ($285,000 amount realized minus $200,000 basis).
To determine how much of her $85,000 in realized gain she must report (recognize), compare the cost of the new home to the adjusted sales price. Here, the ASP is $280,000 ($285,000 amount realized minus the $5,000 in fix-up costs). Since the cost of the new home was only $250,000, Sally must report $30,000 of her gain ($280,000 (ASP) minus $250,000 (cost of new home)).
(Note that if the cost of the new home is $280,000--the ASP of the old home--or more, no gain is reported.)
Example (2): The facts are the same as in Example (1) except that Sally's basis in her old home was $275,000 instead of $200,000. Under these facts, the realized gain on the old home is just $10,000 ($285,000 amount realized minus $275,000 basis). Here, even though the new home cost $30,000 less than the ASP of the old home, there is only $10,000 of realized gain to recognize
.

Basis of new home. If you do defer some of your gain under the rules discussed above, you must reduce the basis of your new home by the deferred gain. This is because the gain is not being erased, merely deferred. By lowering your basis in the new home, the deferred gain gets "built" into it. For example, in Example (1), above, since Sally has a realized gain of $85,000 on her old home, but reported only $30,000, the $55,000 of gain she did not report is subtracted from her cost of her new home. Her basis in the new home is thus $195,000: the actual cost of $250,000 minus the $55,000 of deferred gain.

Other requirements. To defer gain under the above rules, the house you sell and the house you buy must be your "principal" residence. That is, these rules will not apply to the purchase or sale of a second or vacation home.

Further, the new home must be bought within two years of the sale date of the old home. It can be bought before or after the sale of the old home as long as no more than two years come between the dates.

Last, although you can take advantage of these rules repeatedly as you buy and sell your homes over time, you can only do so once within any two year period (unless a sale is caused by a work- or business-related move).

A special form (Form 2119) must be filed with your tax return for the year of sale. I'd be happy to assist you in preparing it.

cpatax@infi.net Created: January 3, 1996 Last Updated: