The Capital Gains Loopholes Are Beginning to Shrink

The Capital Gains Tax has always been a hefty portion of the equation when you invest in real estate. Up until now, the benefits were generous for residents or investors who lived in their homes. Now, however, the tables seem to be turning on the investors.

If you are a homeowner who lives in their primary residence for at least two years and you're single, the capital gains allowance for you is $250,000. If you are living under the same circumstances, but married, the same allowance is $500,000. That has not changed.

Capital gains are assessed on the profit made when selling your house. That is not, generally, equal to the amount of sale.

There has been a change in the law under circumstances where the owner purchased the home, and then rented it for a period of time before taking possession of it as their primary residence for at least two years.

It was once possible to sell the home under these circumstances and convert the profit from renting the home into a tax-free income under the capital gains protection.

Even though the owner has lived in the home as their primary residence for at least two years, as the tax law requires, the time during which it was rented is now considered a taxable period. The new law states the capital gains allowance is to be tabulated pro-rata, and that it shall be divided between the time it was taxable (while it was rented) and the time it was not (while the owner lived there).

Let's draw an example of how this works. You buy a house in June of 2009 for $400,000. You rent it for three years and then live in it for two before selling it in June of 2014 for $700,000. So, you have a net gain of $300,000 for our example. Under the prior set of tax laws, you could use your allowance as a single person to the tune of $250,000. That means you would only have to pay tax on $50,000.

Under the new law, you can claim your capital gains allowance of $250,000, but only against two fifths of the $300,000 you made selling the property. This means that your allowance covers only $120,000 of the money you got for selling the property. That leaves you in the bucket for capital gains tax on the remaining $180,000.

You are now going to pay capital gains tax on $180,000 as opposed to $50,000. Some change, huh?