RESIDENCE REPLACEMENT RULE

RESIDENCE REPLACEMENT RULE - Internal Revenue Code 1034

DEFINITION
Says a home seller MUST defer paying tax on the sale profit if a replacement principal residence of equal or greater cost is bought and occupied within 24 months before or after the sale.

QUALIFICATIONS

• no age restrictions,
• can be used once every 24 months,
• can be used more frequently if move involves a job location change which qualifies for moving expense deduction.

EXAMPLE
Sharp homeowners will readily see they can use IRC 1034 to pyramid their wealth, starting out with a small home such as a cottage, selling it and buying a more expensive home, and then selling that home and buying a mansion--all without paying tax on the profit. All that matters is: (1) your old residence's net sales price (in tax talk it's called "adjusted sales price"), and (2) the replacement home's adjusted cost basis which includes most closing costs.

For example, if your old home sells for $108,000 but you only receive $100,000 after paying the real estate sales commission, transfer fees and closing costs, then $100,000 is your adjusted, or net, sales price. To defer the tax on your sale profit, you must buy a replacement home costing at least $100,000 including closing costs paid on the purchase. However, if you acquire a less expensive replacement home, such as one for $90,000, as in this example, you would owe tax on up to $10,000 of your sale profit ($100,000 minus $90,000). But tax on any remaining profit is deferred. Now, if you add at least $10,000 of capital improvements to your new $90,000 home within the 24-month replacement period, thus bringing your total purchase cost over $100,000, then you can defer tax on all your profit. Please notice the rules say nothing about mortgages or about any cash down payments. If you want to take tax-free cash out of the sale and replacement, the best way to do so is to sell your old home for cash and buy the replacement home for nothing down, such as with a VA mortgage. You can spend the tax-free cash as you wish.