Q: How does selling your home for a profit affect the income you report and your tax liability?

A: Any gain (profit) on the sale of your home can be subject to the capital gains tax. Your gain (or loss) is determined by subtracting your cost basis from your selling price less selling expenses. A loss is not deductible on your return.

However, there can be an exclusion of all or part of your gain. If it was your main home and during the 5-year period ending on the date of sale, you owned and lived in the home for at least 2-years, you can exclude up to $250,000 (single person) or up to $500,000 (married filing joint). The excess amount will still be taxed at favorable capital gains rates. If you can exclude all your gain, you do not have to report the sale on your tax return.

If you do not meet these tests, you still might be able to exclude some of the gain if you meet certain other conditions, such as a change of place of employment, or health. Read the IRS discussion on this topic at this website:

http://www.irs.gov/newsroom/article/0,,id=105042,00.html to see if you qualify for one of the exceptions.

This information is in IRS Publication 523 "Selling Your Home. If you need more details you can obtain them from

http://www.irs.gov/pub/irs-pdf/p523.pdf
or by calling 1-800-829-3676.

Q: I inherited my mother's home at her death. It appraised at $68,000 at that time. Last year it appraised at $95,000, and I sold it for $78,500. I have no idea what her basis is/was. She owned it for 32 yrs. How do I figure my profit?

A: You need to report a gain on schedule D. Your basis is the fair market value at the time you inherited it: $68,000. Your gain is the difference between your proceeds after selling expenses less your cost basis.

The above answer assumes that you have held this home as an investment and it was not rented.

Q: Can I deduct a loss on the sale of my personal residence?

A: No, a loss on the sale of your personal residence cannot be deducted.

Q: Can I defer taxes on the gain on sale of my home by buying a more expensive home?

A: Reinvesting the proceeds from the sale of your main home into a home of greater value no longer defers capital gains tax. That law expired in 1997. It was replaced by a law that allows you to exclude up to $250,000 (single, $500,000 joint return) of gain on the sale if you meet certain requirements.

If the home you sold was your main home during two of the last five years and you also owned that home for at least two years out of the last five years, you would only owe tax, at favorable capital gains rates, on any gain in excess of $250,000. If you're a married individual filing a joint return with your spouse, the amount of gain you can exclude from tax from the sale of your principal residence is $500,000 if both of you meet the two year test for use as your main home. If your gain is less than these amounts, you need not even report the sale on your tax return.

Q: I am married and our house when sold will net about $400,000 in profit. We have lived here for 30 years. If I die before the house is sold, does my spouse lose the $250,00 exemption for me?

A: Starting in tax year 2008, an unmarried surviving spouse who hasn't remarried typically may qualify to exclude from income as much as $500,000 of the gain from the sale of the principal home as long as the sale occurs no later than two years after the date of the other spouse's death. But this rule applies only if the couple would have met the qualifications for the $500,000 exclusion immediately before the spouse's death.

If you live in a community property state and the home is community property, the cost basis is stepped up to Fair Market Value (FMV) on the date of death. If later sold, a realized gain would only occur if the sales proceeds exceed the revised cost basis.

If not a community property state, then only the decedent's half of the house has its basis stepped up to FMV.

See IRS Pub 523 for more information.

Q: I purchased a 2nd home in another state 8 months ago and am about to sell it for a profit. I believe I will have to pay taxes on the gain. Can I reinvest the gain and not have to pay tax on the profit?

A: You are correct. You will have to report the gain. You will use Schedule D to figure the profit.

Since you describe this as a 2nd home, it would be personal use property, not investment property. In the case of investment or business property, there is something called a like-kind exchange where you sell a property and purchase another business or investment property of like nature or character and any gain is not recognized on the transaction but is deferred. Personal use property is not eligible for like-kind exchanges.

Q: I am familiar with the rules for excluding gain on the sale of your main home if you meet the two year rule for ownership and use. What happens if I sell the house sooner? Is the capital gains adjusted or do I pay capital gains on all monies since I didn't stay for the full 2 years?

A: There are a number of exceptions to the 2-year requirement. Tax law provides an exception to the two-year rule when the primary reason for the sale is health, change in place of employment, or, to the extent provided in IRS regulations, “unforeseen circumstances.”

Taxpayers may establish by the facts and circumstances of their situations that their home sales were for one of these reasons. To make things easier, the IRS has identified various “safe harbors” that will automatically establish that the sale is for one of these reasons.

The IRS regulations provide that a home sale will be considered related to a change in employment if a qualified person’s new place of work is at least 50 miles farther from the old home than the old workplace was from that home. This is the same distance rule that applies for the moving expense deduction. The employment change must occur during the taxpayer’s ownership and use of the home as a residence. A qualified person is the taxpayer, the taxpayer’s spouse, a co-owner of the home, or a member of the taxpayer’s household.

A sale will be considered because of health if the primary reason is related to a disease, illness, or injury of a qualified person. If a physician recommends a change in residence for health reasons, that will suffice. In addition to the persons listed above, a qualified person for health reasons includes certain close relatives, so that sales related to caring for sick family members will qualify.

A sale will be considered as occurring primarily because of “unforeseen circumstances” if any of these events occur during the taxpayer’s period of use and ownership of the residence:

* death,
* divorce or legal separation,
* becoming eligible for unemployment compensation,
* a change in employment that leaves the taxpayer unable to pay the mortgage or reasonable basic living expenses,
* multiple births resulting from the same pregnancy,
* damage to the residence resulting from a natural or man-made disaster, or an act of war or terrorism, and
* condemnation, seizure or other involuntary conversion of the property.

Any of the first five situations listed must involve the taxpayer, spouse, co-owner, or a member of the taxpayer’s household to qualify. The regulations also give the IRS Commissioner the discretion to determine other circumstances as unforeseen.

Other than what I have previously mentioned, any sale that violates any of the two year rules, would make you ineligible for any exclusion of gain.