A taxpayer's principal residence is a capital asset. Upon the sale of a principal residence, the taxpayer realizes capital gain or loss. However, no loss is recognized, because a residence is personal in nature. In the case of a sale that produces gain, the Code, as amended by the Taxpayer Relief Act of 1997, provides an exclusion from income for a portion of such gain. Prior to the 1997 Act, two special tax provisions could be used to defer or exclude the recognition of such gain: the former home sale rollover rule and the former age 55 or older exclusion rule.
CURRENT LAW effective 1998
The home-sale exclusion rule allows a taxpayer to exclude from income gain realized from the sale or exchange of property if, during the five-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for a period aggregating two or more years. The exclusion is allowed each time a taxpayer meets the eligibility requirements, but generally no more frequently than once every two years. The age requirement under pre-1997 Act law is eliminated. This new provision replaces the former rollover and former one-time exclusion provisions. The excluded amount is a gain of up to $500,000 married filing joint, or $250,000 for a single taxpayer.
OLD RULE Deferred Based on Purchase Price of New Home
The former home sale rollover rule permitted a taxpayer to defer the recognition of gain on the sale of a principal residence if the taxpayer purchased a new principal residence within the four-year period commencing two years before and ending two years after the sale of the old residence. If the cost of the new residence was equal to or greater than the selling price (computed with certain adjustments) of the old residence, no gain was recognized. However, the adjusted basis of the new residence had to be reduced by the amount of gain not recognized. This ensured that only a deferral, rather than exclusion, of gain resulted; the deferred gain would be recognized upon the sale of the new residence (unless rollover treatment applied to that sale).
OLD RULE Based on Age 55
The former age 55 or over exclusion rule allowed a taxpayer who was at least age 55 at the time of the sale of the principal residence to exclude up to $125,000 of gain. The exclusion was elective, and could be used only once during the taxpayer's lifetime. To qualify for the exclusion, the taxpayer must have owned and used the property as a principal residence for at least three of the five years preceding the sale. In the case of a sale of a residence jointly owned by spouses, one of whom satisfied these requirements, both spouses where treated as satisfying the requirements.
Under IRC 469(g), current and carryforward passive activity losses are fully deductible in the year of an entire disposition in a fully taxable transaction to an unrelated party. A qualifying disposition may create a Net Operating Loss (NOL) which can be carried back. See IRC § 172
Once the amount of Cancellation of Debt (COD) income is determined, IRC § 108(b)(2) requires the taxpayer to reduce tax attributes in the following order:
(A) Net operating losses (NOL);
(B) General business tax credits
(C) Minimum tax credits
(D) Capital losses;
(E) Property basis;
(F) Passive activity loss and credits THIS IS RENTAL REAL ESTATE UNUSED LOSSES CARRIED FORWARD.
(G) Foreign tax credits
Suspended passive losses must first be applied against any relief of indebtedness (debt cancellation). If the debt forgiven under section 108 fully absorbs current and suspended passive losses nothing is deductible on the return.
The same logic applies to NOL’s.
The latest year data available form the IRS indicates the top 10% of US taxpayers in 2011 paid 68.3% of all federal income tax paid in 2011.