Based on comments and questions I have received from clients and readers it appears that there is still some confusion about the rules for taxing gain on the sale of a personal residence. Many people think the "old rules" still apply.

THE OLD RULES:

In order to postpone paying income tax in the current year on gain from the sale of your personal residence you had to "buy up" - purchase, or build, a new home that cost more than the sale price of your old home - within 2 years of the date you closed on the sale of your old home. The tax was deferred for as long as you continued to "buy up", or until you sold your last home.

Homeowners age 55 and older could make a once-in-a-lifetime election to exclude up to $125,000.00 in gain.

These rules no longer exist!

THE NEW RULES:

Thanks to the Tax Reform Act of 1997, if you sold your personal residence after May 6, 1997 you can totally exclude from income tax up to $250,000.00 of gain if single, or $500,000.00 if married, regardless of your age at the time of the sale, if during the 5 years prior to the sale you owned and lived in the home for a total of 24 months (they do not have to be consecutive). This exclusion is not a one-time election - it is available once every 2 years.

If you are married and sell your home, which you and your spouse owned and lived in for 3 years, and realize a gain of $475,000.00 you do not have to pay any income tax on this gain. If the net gain is $525,000.00 you will only pay tax on $25,000.00 at the appropriate capital gains rate.

If you do not own and live in the home for a full 24 months you may still be able to exclude some, or all, of the gain if you had to sell the residence because of certain IRS-approved special circumstances.

You should still keep the original closing statement for the purchase of your home for as long as you own it, and maintain documentation on all capital improvements made to the home over the years just in case.