Your Money: Saving taxes when you sell your home

Q. I have lived in my house for 30-plus years. I have been told that if I sell it for more than I paid for it, I will have to pay capital gains tax on the difference between what I paid for it and what I sell it for. Others tell me this is not the case, saying I can sell it for more than I paid and invest in another house of lesser value. Can you help me, please?

— Homeowner

A. If we’re talking about your principal residence, there are exceptions for you when it comes to taxes.

If you sell a second home, such as a house at the lake or a beach vacation home, all gains are subject to federal and New Jersey income tax, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

Once a second home or vacation home is sold, there is no way to avoid the tax.

But when you sell your principal residence, you are entitled to special tax treatment on both your federal and New Jersey income tax returns.

Kiely says if a single person sells their primary residence, the first $250,000 of gain is forgiven under both federal and New Jersey tax laws. In the case of a married couple, the first $500,000 of gain is forgiven.

“This is so even if only one spouse owns the house, just as long as both spouses lived in the home,” he says. “Any gain above the $250,000/$500,000 is subject to both federal and New Jersey income taxes.”

To be eligible for the exclusion, the home must have been your principal residence for 24 out of the last 60 months.** The 24 months do not have to be consecutive months, Kiely said.

This tax rule hasn’t always been the case.

Under the old law, you could avoid federal and New Jersey tax on the sale of your primary residence if you purchased a new residence of equal or greater value than the sales price of your old home, Kiely said.

“If you were 55 or older, you could take a once-in-a-lifetime exemption of up to $125,000 in profits,” he said. “This all changed for primary home sales after May 7, 1997. It has been 17 years since the law changed, but some people still think it is still the rule.”

Kiely also addressed what happens if you don’t sell, but you live in your highly appreciated home until the day you die.

In that case, the home would pass to your heirs as named in your will (or per state regulations if you don’t have a will).

“Your heirs would get what’s known as a ‘step-up in basis’ in your home,” Kiely said. “The cost basis on inherited property is adjusted upwards for your heirs.”

The step-up in basis essentially eliminates all the capital gains taxes that have accumulated over the years, he said.

It doesn’t just apply to real estate, but to all assets, including stocks, mutual funds and bonds.

“If you gift someone a highly appreciated asset you gift them your low-cost basis,” he said. “Selling a recently received gift of property could result in a hefty tax bill. Remember it is better to receive property as an inheritance than as a gift.”