Increase the Exclusion for Gain on the Sale of Principal Residence
- Dr. Mark Lee Levine, Professor
- 3 days ago
- 5 min read
Most folks in the real estate business, be they in commercial or residential real estate, know what is often labeled as the Exclusion Rule relative to the sale of the principal residence. In fact, almost anyone that has sold their principal residence at a gain has heard of and possibly used this exclusion provision on their own tax return.
Briefly stated, this rule under the Internal Revenue Code, Section 121 (26 USCA Section 121), permits the exclusion of part or all the gain from the sale of a qualified residence.
The language of Code Section 121(a) states: “Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more.”
As to how much gain can be excluded, the subject of this Tip, as noted below, is covered under Code Section 121 (b), which states:
“(1) In general
The amount of gain excluded from gross income under subsection (a
with respect to any sale or exchange shall not exceed $250,000.
(2) Special rules for joint returns
In the case of a husband and wife who make a joint return for the taxable year of the sale or exchange of the property-
(A) $500,000 Limitation for certain joint returns
Paragraph (1) shall be applied by substituting "$500,000" for "$250,000" if-
(i) either spouse meets the ownership requirements of subsection (a) with respect to such property;
(ii) both spouses meet the use requirements of subsection (a) with respect to such property;….”
This Section provides a limit that there can be only one sale or exchange under this rule, as to the exclusion, within a two-year time frame. (Code Section 12 (b) (3)).
There are many other exceptions and qualifications that impact potentially qualifying under this Section. However, ignoring most of those items for now, the focus of this Tip is to encourage Congress and others impacting Congressional action in this area to consider that it is time for Congress to increase the limits, noted above, for the exclusion. That is, the limit on the exclusion amount has been and continues to be a maximum of $250,000 for the taxpayer who qualifies under this exclusion rule, but who is not filing a joint return with his or her spouse. As noted above, the exclusion, if qualified under the above rule, is a maximum of $500,000 for the married couple filing a joint return.
To tie the above discussion with another issue, namely affordable homes, we can also consider that it has been difficult for many people, younger individuals, couples, and others, to find an affordable residence to purchase.
Related to the affordability issue are such concerns as the price of a home, the downpayment required, interest charged, monthly payments, other costs of home ownership, etc. The daily news is full of the concerns that the Dream Home, the Initial Home, is difficult to purchase with all the hurdles a buyer or buyers must face, some of which were noted above.
If this is an accurate picture today as to concerns with attempting to acquire the principal residence, the question is asked as to what can be undertaken to help alleviate many of these financial and related issues that appear to be roadblocks for the first time home purchaser.
There are, as noted, many obstacles hindering the purchase of an affordable home. Recently, President Trump suggested that a 50-year loan could reduce the monthly payments, thus possibly addressing one of the many concerns for the new home purchaser, viz., the problem with the monthly payments when considering the principal and interest payment each month. This monthly payment is a valid consideration for the potential home purchaser. There are many other concerns in addition to the monthly payment.
What other issues present an estoppel posture for the new home buyer? Another major problem for the potential buyer addresses the number of homes in the market that meet the needs of the buyer. This issue also relates to a potential seller of a home that does desire to sell and “move up” to another home or otherwise make a change by selling the home. However, such homeowner is plagued with the tax burden that might fall on the seller when the home is sold. Yes, the taxable amount is reduced if the taxpayer/seller can meet the Code Section 121 requirements, listed above. In such an instance, some gain can be excluded. However, there is the remaining taxable amount that may discourage the homeowner from selling the home. This may be very likely in a setting where the homeowner might have purchased the home many years ago, lived there while it appreciated, and then, when selling, considers the tax burden, even with the exclusion.
If, for example, X, homeowner purchased X-1 home for $125,000 twenty years ago, with a current value of $1,125,000, the taxable portion of 1 million gain, even reduced by the $250,000 amount noted above, leaves the taxpayer facing a taxable amount of $750,000. The tax owing because of this sale may discourage the seller, X, from selling. (There are, of course, other considerations for X, such as facing the market as a buyer, trying to acquire a home after disposing of X-1.)
However, the point of this Tip is that although the exclusion of the potential $250,000 is helpful, with the appreciation of the X-1 house, X faces a substantial tax burden, which burden may discourage him from placing his house on the market. The failure of homeowners such as X in opting to sell means there are less houses available in the market which other buyers, seeking their first home, might have the opportunity to acquire.
This issue of the tax burden could easily be addressed by Congress passing legislation that increases the amount of exclusion for a seller. Congress, if so acting, might also include an escalator clause that increases the exclusion with a cost-of-living index or some other index that allows the exclusion to be increased, ipso facto, as the value of homes is increased.
There are many other burdens faced by potential first time homeowners. Thus, there are many changes that need to take place to remove barriers for the first time home buyer. The increase in the exclusion of gain on the sale of the principal residence is one of these barriers that may allow for more housing to be available in the market. The National Association of Realtors has been advocating for this change of the exclusion amount for many years.
By Dr. Mark Lee Levine, Professor of Real Estate, University of Denver
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