Tip No. 3: 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 any federal income taxes on gains up to $250,000, and married couples (filing jointly) can exclude up to $500,000. Of course, to fully qualify you must have owned and used the property as your main residence for at least two of the past five years. (For more on the eligibility rules, click here.)

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 2000 return. Internal Revenue Service regulations state that if you sold your home because of a change in job location or due to health considerations, 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. Lucky you, the home was in a hot market and appreciated dramatically 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 on the sale.

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.) 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.

In the future, IRS regulations may also allow the prorated gain-exclusion break for home sales triggered by certain "unforeseen circumstances." Unbelievably, this language is already in the tax code, but until the IRS clarifies what those circumstances might be, not even the most aggressive CPA will venture into these waters. Will that happen this year? Nobody knows, but this language has been in the tax code since 1997, so it doesn't seem like Uncle Sam is in much of a hurry to make things any clearer. For tax year 2000, at least, the break will remain limited to sales forced by job-location changes and health concerns.