I came across this article in the WSJ today and was surprised to see it. Embedded in the 700-page housing bill that President Bush signed into law was a change to the way the IRS will allow homeowners to exclude capital gains tax for the sale of a primary residence.
Under the previous rules a homeowner could exclude up to $500,000 ($250,000 for an individual) of a capital gain on the sale of their primary residence so long as they lived in the home for 2 of the previous 5 years from the date of sale.
For example, a couple buys a home in Portland for $375,000 on January 1, 2005. They live in the property for 3 years as their primary residence. During their time in this home they also buy a vacation property in Bend for $300,000 on January 1, 2007. On January 1, 2008 they sell their primary residence in Portland for $500,000 ($125,000 gain) and move into their vacation home in Bend and occupy it as their primary residence. On January 1, 2009 they sell their home in Bend for $500,000 ($200,000 gain).
Under this scenario the couple would be able to exclude the $125,000 capital gain they incurred on January 1, 2008 when sold their home in Portland as well as the $200,000 capital gain which they incurred when they sold their property in Bend on January 1, 2009. This is known as “house-hopping”.
Under the new law this will no longer be the case. Because the home in Bend was allocated for 1 year of “non-qualified use” out of 3 they would only be able to exclude 2/3rds of the $200,000 capital gain from tax. The remaining 1/3rd would be subject to capital gains tax.
For most Americans this change to the capital gains tax exclusion will not have an impact. However, for many others this is bad news.