Nope. She would pay ZERO taxes on capital gains up to $500,000, under current law. And this is a cap gain. So only $200,000 would be taxable. Also, since eminent domain is being used, she could negotiate a tax abatement from the State for the additional amount. She might still pay Federal on the $200,000, but she would net approx. $600,000 (or more) for a $400,000 home. Not bad. And if it were me, I would get a good attorney and negotiate a larger payment, say $800,000.
In 1997, the rules on exclusion of gain from the sale of a principal residence changed to benefit the taxpayer. The changes resulted in a greater excludable gain and no age limitations. This means that taxpayers give up fewer dollars to taxes and have more dollars to invest. Briefly:
- An unmarried individual may exclude from income up to $250,000 of gain realized on the sale or exchange of a principal residence
- Married individuals may exclude $500,000 of gain Losses on sale of a residence are personal losses, and therefore, not deductible
- Only gains in excess of the excludable amount must be reported on Schedule D and receive capital gains treatment Ownership and use tests must be met:
-- Owned the home for at least two years, and
-- Lived in the home as main home for at least two years
In the example given, if she received $700K for the home she paid $110K for (assuming no improvements), her cap gain is $590K. She will owe cap gain taxes on $90K, if married, or $340K, if not.