More On the Tax Benefits of Home Ownership

As we have already discussed in the Tax Planning section, home ownership is the single biggest factor that will make an itemizing taxpayer out of you.  Your home will open up the availability of a whole menu of Itemized Deductions in addition to the two big deductions associated with home ownership: mortgage interest expense and real estate property taxes.

For the vast majority of Americans, home ownership is our one true "tax shelter."  Look again at the Example on page 13 of how the tax savings associated with home ownership can catapult you from being a home renter to a homeowner. That Example gives you an excellent illustration of the year-to-year tax benefits afforded homeowners.

Not only are there current "front-end" tax benefits of home ownership (noted in the Example), there are also "back-end" tax benefits to home ownership – relating to the sale of the home – that are as significant and pro-taxpayer.  The old rules on taxing the sale of the home were extremely complicated.  Thankfully, Congress has recently and significantly changed and simplified the rules.

The new rules are oriented around the fact that when homeowners sell their home, there frequently is a large amount of inflationary gain recognized on the sale.  Additionally, Congress recognized that the value of the home is the single most important asset (along with private retirement plan benefits) for the vast majority of Americans.  Therefore, the new rules allow for a significant tax holiday on the sale of the home.  How much?  Up to $250,000 of gain is excluded from taxation if the homeowner is single and the exclusion is doubled to $500,000 if the homeowner is married.  The rules require that the home must have been owned and used by the taxpayer as his or her principal residence for at least two years during the five-year period preceding the sale of the home.  If the taxpayer is married, at least one of the spouses must meet the two out of last five-year ownership requirement and both spouses must meet the two out of last five-year use requirement..

It is not the selling price alone that measures the gain on the sale of the home.  It is the selling price (minus selling expenses) less the "tax basis" in the home that measures gain.  The tax basis of the home is generally the cost of the home being sold plus significant improvements.

Example:  Lisa sells her principal residence in which she had a tax basis of $100,000 for $600,000.  She has owned and lived in the home as her principal residence for the last 10 years.  Her selling expenses (primarily real estate brokerage fees) are $50,000.  Although the home is in Lisa's name only, she is married to Mike and the couple files a joint return.  Mike has lived in the home since he married Lisa four years ago.  The realized and recognized gain on the home sale is computed as follows:

                        Selling Price                               $600,000

                        Minus Selling Expenses:             ($ 50,000)

                        Minus Tax Basis:                      ($100,000)

                        Realized Gain                            $450,000

How much of this realized gain is recognized and taxed?  None – up to a $500,000 gain is insulated from taxation.  Both spouses meet the two out of five year use requirements and Lisa meets the two out of five-year ownership requirement.