Last week, we looked at tax benefits for homeowners, a topic that frequently sparks questions such as these:

Q: What is required to qualify for a tax exclusion on up to $500,000 in profits when I sell my home?

A:  You are referring to Section 121 of the IRS code, sometimes called the Principal Residence Rule.

In a nutshell, you must own and occupy the home as your principal residence for any two of the past five years that end on the day you sell. The two years you occupy need not be continuous, so you might live there a year and a half, rent for three years, move back in for six months, then sell. Because you had owned and occupied for a total of two years during the five years preceding the date of sale, you would qualify.

The exclusion is limited to $250,000 per owner. In order to exclude from taxation a total of $500,000, you would have to have two owners, each getting the maximum exclusion of $250,000. A husband and wife need not have both names on the ownership deed to qualify, but they must file their tax return jointly.

Q:  What about state tax on the gain?

A: Most states, including Georgia, have conformed to the federal rules for this exclusion. If you owe no federal tax on your gain, you would be free from taxation under Georgia tax rules.

Q: Don't I have to reinvest the profits in another house?

A: No, but that is a common misconception. You are thinking of the old rules, which allowed you to "roll over" your gain into your next residence if you reinvested within two years. The law was completely rewritten in 1997, and the rollover rules were replaced. Likewise, the "once in a lifetime" exclusion was replaced with the new rule.

Q: Which is better for the average homeowner?

A: In my opinion, the new rules are much more generous to the typical homeowner. Here's why:

• Now you can exclude from taxation up to $500,000 every two years for the rest of your life. Very few owners can amass a gain of more than that in less than two years.

• You no longer are forced to keep buying more expensive houses to roll your gain forward until age 55.

• The only people hurt by the new rules are owners of multimillion-dollar homes that might go up in value far in excess of the limits. They have little choice except to pay capital gains on the amount of their gain exceeding the limit.

Q: So if I have a house that has gone up in value about $500,000, should I sell it quickly?

A: Not necessarily. First, it usually isn't a good idea to allow investment decisions to be driven by tax consequences. Second, you should talk with an accountant about the tax impact of any major life event, and selling your home is one of them. But there are several advantages to selling your home as your profit approaches the Section 121 limits.

Once your gain exceeds the limit of $250,000 per owner, all additional gain will be taxed when you sell. That can act as a disincentive to make improvements. And while the cost of the work and materials may add to your basis and not be taxed, any appreciation from those improvements will be subject to taxation.

By using the exclusion now, you are locking in the tax-free nature of the transaction. Although we never know what Congress might do, the law could be changed sometime and the formula rewritten to your disadvantage. Most tax law changes are effective on or near the date they were proposed. Past transactions are not affected.

Many homeowners who are senior citizens live in a house that is better suited to raising a large family. They may have owned several progressively more expensive homes and now want to downsize. This is easily accomplished under the current rules and can allow the owner to sell and buy a less expensive home while pocketing the profits.

The current rules also allow maximum benefits for owners of both an appreciated residence and an appreciated vacation home. By selling the current residence and moving into the vacation home, the owner can take the full exclusion on both residences. The vacation home now becomes the new principal residence and qualifies for a full tax break after two years of occupancy.

Q: How do I prove that a house is my principal residence?

A: By residing there. In an audit, the Internal Revenue Service will look at the evidence. Where did you sleep? Where are you registered to vote? What is on your driver's license? Where do you have the mail or newspaper delivered? Where is your phone listed?

Next week: More common questions about real estate tax.

John Adams is a broker and investor. His Web site is www.money99.com.