PRIMARY RESIDENCE RULES SUMMARY

Most real estate agents and brokers are familiar with the changes created by the 1997 Taxpayer Relief Act. This Act repealed the old §1034 rollover provision and one-time exclusion of $125,000 at age 55. Although the revisions to §121 are a tremendous benefit to property owners, some frequently asked questions still need to be addressed. Let's review key

FREQUENTLY ASKED QUESTIONS (FAQ's)

Q. Do the two years have to be consecutive?
A. No, you can live in the property for one year and rent for one, then live there one year, etc.

Q. What if I convert my primary residence to a rental for more than three years, can I take advantage of the tax exclusions under §121?
A. Unfortunately not. The residence is no longer deemed a principal residence. You would be required to occupy it again for two years.

Q. Can the home be depreciated during the rental period and still qualify for the §121 exclusion?
A. Yes, however, depreciation taken after May 6, 1997 must be recognized in the year of the sale.

Q. If I convert my primary residence to a rental, how long does it have to be rented to qualify for a §l 031 tax deferred exchange?
A. There is no definitive answer in the tax code that directly addresses this question. Under § 103 1, you may defer capital gain taxes when like-kind properties, which are "held for investment," are exchanged. Many tax and legal advisors believe that at least one (1) year of ownership is a reasonable minimum time frame. The owner must be able to support the fact that the home was legitimately converted to a rental that was "held for investment.'

WHAT DOES THIS ALL MEAN? OPPORTUNITY!

• $ Home owners ("empty nesters") can downsize without a huge tax penalty.
• $ The potential exists for tax-free dollars to be used for the purchase of investment property.
• $ Convert a vacation home into a primary residence and take advantage of the tax exclusion in 2 years.
• $ Serial homebuyers! Buy and live in a "fixer home" for two years and keep the profit!

Selling your home and moving into another one is seldom an easy decision. But,
recent tax law changes might make your decision a little more profitable. As part of
the Taxpayer Relief Act of 1997, Congress included a provision that will eliminate
(not defer but eliminate) the federal income tax liability on the gain on the sale of
a principal residence, for most people. We'll look at this provision in detail and
discuss the planning opportunities available to you that may allow you to slash
your income taxes.

The BasicsUnder the new law, generally effective for property sales after May 6,
1997, up to $250,000 of the gain from the sale of a single person's principal
residence is tax-free. That's right -- tax-free. And, for certain married couples filing a
joint tax return, the amount of tax-free gain doubles to $500,000. TAX FREE!

This law replaced the old personal residence sale rules. No longer do you have to
"roll over" or "buy up" in order to defer your gain to a later tax year. You also no
longer have to concern yourself with the "over-age-55, once-in-a-lifetime" rules
regarding the exclusion of $125,000 of your gain. All of the old rules are
effectively out the window (with some minor exceptions that we'll discuss in detail in Part
II).

The rules allowing you to take your home sale profits tax-free apply regardless of
your age and regardless of how many homes you might sell in the future or have sold
the past. It is available to you even if you previously took a "once-in-a-lifetime"
exclusion. As long as you meet the qualifications, this exclusion is available for
you. Right now.

Example #1: Sam, age 31, sold his personal residence this year for $130,000. Sam
originally bought this residence in 1994 for $85,000. Sam's gain on the sale of his
principal residence in the amount of $45,000 is excluded from tax, and Sam can use
these funds however he sees fit. He doesn't have to buy another home and he doesn't
have to be over age 55.

Example #2: But, Sam decides to purchase another home, and closes escrow on the new
home in August of this year. His purchase price was $110,000. In October, two years
later, Sam sells this new home for $160,000. The $50,000 gain on the sale of this
home is also excluded from tax. No tax to be paid whatsoever. In effect, over a
matter of just a few years, Sam has managed to take $95,000 in home sale profits tax
free.

And remember, the new exclusion rules will apply even if you previously qualified
for and took your "once-in-a-lifetime" tax exclusion on a prior home sale.

Example #3: Jack and Jill sold their home for $265,000 in January of this year.
They originally purchased this home in 1991 for $185,000 using the proceeds from a
previous sale that took place in 1990. On the 1990 sale, they took the
"once-in-a-lifetime" exclusion since they were over age 55 then and met all of the other
qualifications. Jack and Jill are still able to exclude the $80,000 gain on the sale of
their current residence. The fact that Jack and Jill used the "once-in-a-lifetime"
exclusion in the past does not prohibit them from using the current tax laws to exclude
their gain on the most recent sale.

Finally, remember that any gain in excess of the exclusion amount WILL be subject
to taxation, and there is nothing you can do to get rid of that taxation. You cannot
"roll over" any gain into a new residence, because those prior "rollover" rules are
no longer applicable.

Example #5: Janet bought her home in 1961 for $25,000. Over the years, Janet paid
$45,000 for improvements to the property (new laundry room, new roof, updated
kitchen, etc.). Janet sold her home this year for $365,000. Janet can exclude $250,000 of
her total gain of $295,000 but, she must pay tax on the $45,000 gain in excess of
the exclusion amount. And, there is nothing that she can do to otherwise defer or
exclude that portion of the gain. While the gain will be subject to the new, generous
capital gain rules, Janet must still "belly up to the bar" and fork some tax
dollars over to Uncle Sammy.
RestrictionsLike virtually all other tax laws, there are some restrictions. This
exclusion has a detailed set of rules that must be followed to qualify for the
exclusion. Besides the $250,000/$500,000 dollar limitation noted above, the seller must
have owned and used the home as his or her principal residence for at least two
years out of the five years before the sale. And, while the two years don't have to be
consecutive, in most cases you can only take advantage of this gain exclusion
provision once during a two-year period.

In Part II, we'll discuss these restrictions in greater detail. But, also feel
free to take a look at IRS Form 2119 and the associated instructions and/or IRS
Publication 17 (especially Part 3).

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Stewart Title of California Inc.

10125 Cupertino, CA 95014