New Restriction on the Home Sale Gain Exclusion
You're probably aware that you are allowed to realize up to $250,000 in tax-free profit from the sale of a home (up to $500,000 for married couples) as long as it was your primary residence for two of the five years prior to the sale.
Did you know that this is about to change? Apparently the IRS got tired of investors avoiding paying capital gains tax by moving into their own rental properties and using them as a primary residence during the two years prior to a sale.
Beginning January 1, 2009, if a property has been a rental and is then converted to a primary residence, the time during which it was rented is deemed 'non-qualified' use. The amount of gain that is not taxable is reduced by the proportion of non-qualified use during the five years prior to the sale.
Example:
Assume that after 2008 a home is rented for three years and then occupied by the owner for two years. It is then sold with a net gain of $100,000.
Under the new restrictions, only $40,000 of the profit would be non-taxable, since the home was a primary residence for only 40% of the preceding five year period.
Important:
- The new restriction only applies to occupancy and sales that take place after 2008.
- If a home is first used as a primary residence and subsequently vacated by the owners, the time during which it is not owner-occupied does not count as non-qualified use for that five year period.
In other words, it appears that if the use periods in the above example were reversed so that the owner occupancy took place first, the entire gain could be excluded.
Please note! This is new legislation and the information presented here is for educational purposes only. Please consult a legal or accounting professional before making any decisions based on the home sale gain exclusion law.
Mortgage Interest Rates: On Their Way Up?
While no one knows for certain, many experts predict that interest rates will gradually increase. In a recent interview with U.S. News, Weiss Research analyst Mike Larson said it would not be unlikely for us to see a one-half percent increase on a 30-year fixed mortgage rate in six months, and a one percent increase a year from now.
With the 30-year fixed rate still historically low at around 6 percent, now is a good time for homeowners with variable rate loans to consider refinancing into a fixed rate loan.
For home buyers waiting for housing prices to drop, it's a good time to evaluate how a change in interest rate affects buying power. (See the section below.)
How a 1% Rate Increase Affects Buying Power
In most areas of the country home buyers are behaving cautiously, often holding back from making offers until the day-to-day economic news stabilizes, or putting a purchase off entirely for six to twelve months in the hopes that home prices will decline.
What happens if interest rates increase? They face a trade-off, even if prices do go down.
Here's an example of how a one percent increase in mortgage rates affects buying power:
- A homeowner with a $300,000 mortgage at a 30-year fixed rate of 6% pays around $1798 a month for principal and interest (not including insurance and taxes.)
- The same loan at 7% has a monthly payment of around $1996 per month, nearly $200 more.
- In order to keep the payment at around $1798 the loan amount would have to be decreased by approximately $30,000, to around $270,000.
In other words, the one percent increase in mortgage interest rate translates into about a 10% drop in the loan amount that can be obtained at the same monthly payment. (At higher interest rates this becomes slightly less accurate, but it is still a good guideline.)
It's also worth noting that the homeowner pays nearly $40,000 more in interest over the life of the 7% loan.
(Please note: The information in this newsletter is not presented as professional financial or legal advice. Please always consult a qualified expert when making financial or legal decisions.)
Do you have questions about any of this material, or are you simply wondering how your real estate plans fit into today's market? Call me, or just click 'Reply' to this email and I'll be happy to provide you with helpful information.
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