A subject that is frequently discussed in real estate, but often misunderstood, is the Taxpayer Relief Act of 1997. Tax and relief are so rarely used together, but in this case it’s true and most home sellers can benefit from it. What this act refers to specifically is the exclusion of capital gains on the sale of a principal residence, which more simply can be understood as the tax benefit associated with selling a home.

In 1997 legislation was passed that fundamentally changed the treatment of gain on the sale of a residence. The Act replaced a previous provision that benefited few and frustrated many. In its place amended Code Sec. 121 was created, stating that an individual may exclude from income up to $250,000 of gain realized on the sale or exchange of a residence. The exclusion increases to $500,000 for joint filers.

In general terms what this means is that if you and your spouse purchased a home for $100,000 and sold it ten years later for $600,000, you would be exempt from capital gains because the gain does not exceed the established $500,000 limit. A common misconception is that in order to avoid paying capital gains you must rollover the gain into another, more expensive residence. This simply isn’t true. One of the primary benefits of the Act of 1997 is that it allows homeowners to choose the type of housing they want without worrying about the tax consequences. It is also designed so that house sellers can take advantage of the tax benefit once every two years, unlike the onetime exclusion of the previous Act.

With all these benefits are some strict guidelines that must be followed. For example, in order to qualify for exclusion you must have owned and occupied the residence for a minimum of two of the last five years from the date of sale. In other words, if you sold your home on Sept. 26, 2000, the law states that you are required to have lived in that residence for two years (not consecutively) between September 26, 1995 and September 26, 2000 to qualify. For obvious reasons, properties intended solely for renting are exempt from this particular tax benefit, however often times rentals and vacation homes can qualify if they have served as a primary residence for the home owner during the five year allotment.

Something else to keep in mind is that any gains you incur above the $250,000 and $500,000 limits will be taxed at the 20 percent capital gains rate, however beginning in 2001 home owners who occupy their homes for more than five years may qualify for an even lower capital gains rate of 18 percent.

The whole point of the Taxpayer Relief Act of 1997 was to streamline the system, giving homeowners greater flexibility without having to make home buying/selling decisions based primarily on tax considerations. What I have outlined here are the general terms of the 1997 federal tax bill, for further information consult a tax advisor or your local real estate office.

(Editor’s Note: J. Lennox Scott, is president of John L. Scott Real Estate. He may be reached at realnews@johnlscott.com, or visit his firm’s award-winning website at www.johnlscott.com.).