11. Tax Breaks on Home Sales

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Even if you lived in your house for less than two years, you might still be eligible for a tax break. Here's how to save.

You probably already know that selling your home at a profit provides one of the greatest tax breaks around. Singles can avoid federal income taxes on gains up to $250,000, and married couples (filing jointly) can exclude up to $500,000. Of course, to qualify you must have owned and used the property as your main residence for at least two of the past five years.

But what if your ownership period was shorter, and you sold last year? Fact is, you could still be eligible for at least a partial break on your 2004 return. Tax law stipulates that if you sold your home because of your job, health considerations or certain unforeseen circumstances (such as a divorce or separation, a pregnancy that results in multiple births or the death of someone whose primary residence is your household), you qualify for a prorated (reduced) gain exclusion. And this prorated exclusion will probably still be enough to shelter your entire gain, as the following example illustrates.

Say you and your spouse sold your home last year after owning it for just 18 months. The reason for the sale: job transfer. Luckily for you, the home was in a hot market and appreciated even during the short time you lived there. Under the prorated gain-exclusion rule, you and your spouse can exclude up to $375,000 of profit on your joint return. Here's the math: You owned and used your old home for 18 months, instead of the required 24. Divide 18 by 24, and you get 75%. Three-quarters of the "normal" $500,000 joint-return allowance equals $375,000. Not too shabby -- in most cases, that should be more than enough to completely shelter your gain from any federal tax.

The tax results would be the same if the sale of your home were necessary because of health reasons. (If, for example, you developed chronic knee problems and were forced to sell your two-story colonial and move into a one-story ranch-style home.) Just be sure to get a letter from your doctor to back you up should you get audited. And keep that letter with your permanent tax records.