QUESTION:
How does the Over-55 Rule work?
ANSWER:
THIS IS OLD LAW. IT NO LONGER APPLIES BUT IS HERE FOR HISTORICAL
INTEREST
OVER-55, ONCE IN A LIFETIME RULE
If you or your spouse are over 55, you might be eligible to exclude up to $125,000 of
profit from the sale of your residence (in which you resided for 3 out of the 5 years
before the sale).
One spouse must meet all 3 requirements: age, ownership, and residence.
This benefit may be used only once. If you or your spouse ever took advantage of this
rule (even before marriage), both of you are disqualified, as long as you are married,
even if you only used it partially (to protect less than $125,000 of profit).
The Over-55 Rule and the rollover of primary residence may work in conjunction as
follows:
- First compute the potential profit if you do not buy a new home. Reduce the adjusted
sales price by the cost basis and the first $125,000 of profit. This is your potentially
taxable profit.
- Second, compute the target purchase price to avoid all tax: adjusted sales price (sales
price less costs of sale) less $125,000.
- Third, if you buy for less than the target cost (to avoid all tax) some portion may be
taxable.
That taxable amount is the lesser of:
1) total profit and
2) the shortfall under the target price to avoid all tax.
- Step 1: Determine Profit:
If you sell your home which cost $35,000 for $245,000 (and incur $10,000 costs
of sale), you have $200,000 profit. [Adjusted sales price of $235,000, less cost.]
If you qualify, $125,000 of profit is forgiven [Over-55 Rule], leaving $75,000
potentially taxable profit.
- Step 2: Determine Target Cost for Rollover:
Adjusted sales price of old home, $235,000, less $125,000 exclusion, equals
$110,000 target price of the new home to avoid all tax.
- Step 3: If you buy for less than $110,000, the lesser of your total profit [$75,000] or the amount below the target [$110,000] is taxed.
- If the new home costs more than $110,000, nothing is taxable.
- If the new home costs $80,000, the reduction below the target price is $30,000
[$110,000 -$80,000]; the profit is $75,000; $30,000 (the lesser of $30,000 or
$75,000) is taxable.
- If the new home costs $30,000 it does not save any taxes. The reduction below
the target price is $80,000 [$110,000 - $30,000]; the profit is $75,000; $75,000
(the lesser of $80,000 or $75,000) is taxable.
This may be changed by the new Tax Act. See Tax Act.
For more information, see Home Owner's Tax Manual
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