Capital Gains Exclusion Once-in-a-Lifetime Break : Taxation: Provision presents complications when widowed or divorced people remarry in their later years.
NEW YORK — When you are navigating the tricky waters of the U.S. tax system, even the most generous benefits need to be approached with caution.
Consider, for example, the much-beloved capital gains exclusion that people age 55 or over can claim when they sell a home.
On the surface, this tax break certainly seems simple and sensible enough. To allow for the effects of inflation over the years and help people finance their retirements, the law permits older Americans to exempt up to $125,000 in profits on the sale of a primary residence from any tax liability.
But as soon as you get to the provision in the rules that limits this break to once in a lifetime, the situation starts to get more complicated.
In a case that eventually wound up in the Tax Court, a woman who sold a home in 1988 sought to claim the exclusion on her $112,000 gain.
There was a hitch, however, involving a previous home sale by the same woman, in 1979, which produced a $7,000 profit.
At that time, she had reinvested all the proceeds in a home of equal or greater value, thus qualifying for mandatory deferral of all capital gains taxes under a separate provision of the law.
Unfortunately, her accountant had elected the 55-and-over exclusion (covered by Section 121 of the Tax Code) anyway on her tax return for that year.
That should make no difference, the woman argued. Since the law required her to defer taxes on the 1979 sale, she was ineligible to claim the 55-and-over exclusion for that deal, and thus should be allowed to use it for the 1988 transaction.
But the court said no. “The Code Section 121 election could have been revoked at any time before the statute of limitations expired, that is, within three years of filing the ’79 return,†said the Research Institute of America, a New York-based publisher of tax information.
“Failing to act within that time period, she cannot now revoke the election.â€
At a capital gains tax rate of 28%, that adds up to a $31,360 mistake.
Timing of the 55-and-over exclusion can also be a minefield for widowed or divorced people who marry again in their later years.
“If one spouse has already taken advantage of the exclusion before a marriage, then after the marriage both are prohibited from taking another exclusion,†noted Cynthia Saltzman and Kenn Tacchino of Widener University in Chester, Pa.
“This brings up an interesting planning opportunity,†Saltzman and Tacchino wrote in the Journal of Financial Planning.
“If two individuals over 55 are contemplating getting married, and both have homes, it is best to sell the houses before the marriage so that both parties can take advantage of the exclusion, assuming neither party has a previous election.
“In addition, if one of the would-be newlyweds has used the exclusion, it may drive the decision to sell the other’s home (taking the exclusion) before the marriage and live in the home of the one who previously used the exclusion.â€
Many other issues may also complicate the decision of whether to take the exclusion now, or keep it in reserve for possible future use.
In addition to all the personal matters that may arise in any individual case, there is the question of whether Congress might sooner or later increase the limit on how much can be excluded, which was last raised--from $100,000 to $125,000--in 1981.
“Of course,†say Saltzman and Tacchino, “speculation of this kind may not be prudent planning considering that Congress is looking for ways to increase revenues, not expand tax breaks.â€
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