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Selling one’s residence and moving into a smaller house or apartment is seldom an easy decision, but at least part of the decision-making process was made a bit easier by the special capital gains exclusion for principal residences enacted as part of the Taxpayer Relief Act of 1997.

This exclusion, which applies to sales and exchanges of a principal residence after May 6, 1997, allows a taxpayer to exclude from taxable income up to $250,000 of the gain from the sale of his or her principal residence. For married couples filing a joint return, the amount of tax-free gain can double to $500,000. Gone are the days when one had to reinvest sales proceeds by buying a more expensive house in order to avoid paying tax on the gain. The new exclusion also replaces the one-time exclusion of $125,000 of gain that could be claimed by individuals over age 55. Because most people will not owe any tax on the gain from the sale of a principal residence under the new law, much of the hassle of documenting costs, expenses, and prices of various residences over the years should be alleviated. However, homeowners with profits exceeding the $250,000/$500,000 limits may have to pay more tax under the new law, because of the repeal of the provision that previously allowed owners to indefinitely defer gains by rolling over sale proceeds into a new home costing the same or more.

To qualify for the $250,000/$500,000 exclusion, the seller must have owned and used the property as a principal residence for at least two years in the five year period before the sale. Special rules apply if you did not reside in your home for two out of the five preceding years, you marry someone who has recently used the exclusion provision, the residence was part of a divorce settlement, you inherited the residence from your spouse, you sell a remainder interest in your home, or you have taken depreciation deductions on the residence.