Capital Gains Exclusions
Determining your principal residence according to the IRS for tax purposes if you own more than one home can be tricky, but the IRS continues to refine the rules. First of all, principal residence can take many forms: conventional home, condominium, mobile home, house trailer, tenant-stockholder cooperative housing unit—even a boat, as long as it has sleeping, cooking and sanitary facilities (a bathroom).
The difficulties arise when you split your time between two different properties during a year. Simply put, the IRS says that your principal residence is the home you own and use as a residence for “a majority of the time during the year.”
But of course, there are other considerations. For instance:
l the location of your property in relation to your place of employment.
l the location where your family members reside.
l the address you use on your federal and state tax returns, driver’s license, automobile registration and voter registration card.
l the mailing address you use predominantly for bills and correspondence.
l the location of your banks.
l the location, believe it or not, of your “religious organizations and recreational clubs.”
To add another complication, but one that can work in your favor: You can switch the designation from house to house each year according to your personal tax strategies. For instance, if you own a house in Revere, MA and a cottage on the Cape that has appreciated substantially, you’ll want to pocket as much as possible of that gain tax-free through a sale.
You can do this by making your Cape Cod vacation cottage your principal residence for two years running by living in it more than six months each year. That qualifies the cottage for the maximum capital gains exclusion of $250,000 for single filers or $500,000 for joint filers if you sell the following year. You then switch your principal residence back to your house in Revere. By living in it and using it for a majority of the time during the two years following the condo sale, it should qualify for the maximum capital gains exclusion.
Also, thanks to the 1997 legislation, you no longer have to be concerned with replacing your residence with another house with an equal or higher purchase price within a certain time frame. No replacement residence is required now. Fixing-up expenses are no longer a factor in determining the deferred gain with respect to a principal residence. The bad news: taxpayers over age 55 are no longer eligible to exclude $125,000 of gain from the sale of a principal residence.
I always recommend to check with a tax professional as the tax laws are always changing.