Beginning on January 1, 2008, the Mortgage Forgiveness Debt Relief Act of 2007, (Public Law No. 110-142) allows a surviving spouse up to two (2) years from their spouse’s date of death of to exclude up to $500,000 of gain from the sale of their primary residence. The new law amends Section 121(b) of the Internal Revenue Code, Exclusion of Gain from the Sale of Principal Residence.
Under the old law, the surviving spouse could only exclude $500,000 of gain if the property was sold within the same calendar year that their spouse died. This proved to be very difficult if the spouse died late in the year. For example, under the old law, if the spouse died on December 1, 2006, the surviving spouse could only exclude up to $500,000 of gain if the house were sold prior to December 31, 2006. If the house was not sold prior to December 31, 2006, then the surviving spouse was limited to excluding only $250,000 of gain when the primary residence was eventually sold.
Additionally, the surviving spouse still is entitled to a stepped up basis on the deceased spouse’s half of the primary residence. The exclusion of up to $500,000 in gain from the sale of the principal residence is in addition to the stepped up basis.