The capital gains benefit for those selling their homes may have gotten tighter with the new housing bill. For most of us, this is not a worry. For those who use 2 years of residence in 5 rule may take a tax hit in the future.

Typically I would try to explain it in my own way, but Tom Herman at the Wall Street Journal has done a masterful job. Take it away, Tom…

For example, consider a married couple with several homes who had lived in their main home for two years or more. They typically could sell their primary residence, exclude as much as $500,000 of the gain from tax — and then move into a vacation home, make it their new primary residence, live in it two years or more, sell it and once again take advantage of the full $500,000 exclusion.

A new twist. Under the new law, you can’t exclude the gain from the sale of the home allocated to periods of “nonqualified use.” That typically refers to any period (after the end of 2008) when the property isn’t used by you, your spouse or former spouse as a principal residence, according to a congressional staff summary. Also, the new law is effective only for sales beginning next year.

Here’s an example: Suppose a married couple buys a home on Jan. 1 next year for $600,000, says Mr. Olivieri of White & Case. They plan to hold it as an investment. On Jan. 1, 2012 — three years later — they begin using it as their principal residence. They live there two years and sell it on Jan. 1, 2014 for $1.1 million, for a profit of $500,000.

Under the old law, they would have been able to exclude the entire $500,000 gain from their taxable income, Mr. Olivieri says. But under the new law, they could exclude only two-fifths of the gain, or $200,000, since the other three-fifths would be considered attributable to the three years the home wasn’t their principal residence, he says. via WSJ.com

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