Dear Liz: I thought I understood about taxes and house sales, but I am now confused. It seems like the previous rules were that home sale profits could be rolled from one house to the next and one would take a one-time exemption for up to $500,000 or so, with capital gains only due on the amount above that amount. Now the latest rule is that house sales are calculated on each sale, but still based on purchase price plus improvements as the basis. Or is it?
Answer: You are confused, but you’re not alone. Many people remember the old rules, and some think they’re still in effect.
The basic way that capital gains are calculated hasn’t changed. The homeowner’s tax basis — which is the amount they paid for the home, plus qualifying improvements — is subtracted from the net sale price to determine potentially taxable capital gains.
Before the Taxpayer Relief Act of 1997, homeowners could defer capital gains on home sales if they bought a replacement house of equal or greater value. At age 55, they could take a one-time exemption that protected $125,000 of home sale gains from taxation. This allowed many if not most people to downsize without owing big tax bills (the median home price in 1997 was less than $150,000).
The rules today are quite a bit different. Home sellers can exclude up to $250,000 of capital gains, or $500,000 for a married couple, as long as they owned and lived in the home at least two of the five years prior to the sale.
Note, however, that the exclusion amount hasn’t changed since 1997. The median home price in the U.S. is over $400,000, and “starter” or entry-level homes top $1 million in over 200 cities, according to real estate site Zillow. That means many more longtime homeowners face capital gains taxes when they sell their homes.