My wife and I own a house in California that we purchased in 1996 for
$300,000.  We're in escrow to sell our current house for $1,000,000. 
We are in a simultaneous escrow to purchase our new primary residence
for $1,200,000.  We plan to roll over all of our proceeds into the new
house.  Will we have to pay any taxes?  For example, we realize that
if we simply sold our primary residence, we can only shield a $500K as
a married couple.  Therefore, our profit is $700K ($1MM - $300K) and
we would then pay capital gains on $200K ($700K - $500K).  However,
since we're rolling all the proceeds into a new primary residence, and
our gain is greater than $500K, will we have a tax obligation?

Howdy fragrantgas-ga,

A reminder of the "Important Disclaimer: Answers and comments provided on
Google Answers are general information, and are not intended to substitute
for informed professional medical, psychiatric, psychological, tax, legal,
investment, accounting, or other professional advice."

The short answer is that there will be tax implications from the sale that
you outline.

The commenters are no doubt thinking about the "rollover replacement rule"
that was replaced by the Taxpayer Relief Act of 1997.  Under the old rules,
capital gain taxes could have been deferred in your case, but that is no
longer true.

Instead, your simplified example will be the case, that is, you will have
capital gains tax to pay on the approximate $200,000 end profit of the sale.

There is a article by Ilyce R. Glink on her "ThinkGlink" website which
addresses a situation similar to yours.
http://www.thinkglink.com/Understanding_State_Tax.htm

Summary: A reader is moving from California to Idaho and would like to
limit their state tax liability on capital gains.  Ilyce explains that
the "rollover replacement" rule was thrown out ..."

The above article points out that you will want to read Internal Revenue
Service (IRS) Publication 523, titled "Selling Your Home."
http://www.irs.gov/pub/irs-pdf/p523.pdf

The above publication "includes worksheets you can use to figure your
gain (or loss) and your exclusion. Use Worksheet 1 to figure the adjusted
basis of the home you sold. Use Worksheet 2 to figure the gain (or loss),
the exclusion, and the taxable gain (if any) on the sale. In some
situations, you may also need to use Worksheet 3 to figure a reduced
maximum exclusion."

Those worksheets will give you a better idea on what the actual gains will
be on your sale.

The ThinkGlink article also indicates that you will want to reference the
California Franchise Tax Board (CFTB) as well, as there might be California
state tax implications.  The following is from the CFTB website.

"I sold my personal residence. How do I report the sale to California?"
http://www.ftb.ca.gov/individuals/faq/ivr/219.html

"You must report the sale of your principal residence if you have a gain
and do not qualify to exclude all of it, or you choose not to take the
exclusion.  When you complete your federal tax return, you must complete
federal Schedule D (Form 1040), Capital Gains and Losses.  A copy of your
federal return, and all the supporting schedules must be attached to your
California return.  Generally, your California gain is the same as federal,
so no adjustment is required on your California return. However, if your
California basis in the home differs from your federal basis, complete
California Schedule D, California Capital Gain or Loss Adjustment."

As well, if you used the house for business purposes, that is, took tax
deductions for a home office or similar, then it could get complicated
and have further tax implications.

The ThinkGlink article referenced above concludes with some good advice.

"Finally, be sure to talk with your attorney or tax advisor to make sure
other rules, regulations and laws don't apply in your situation ..."

If you need any clarification, please feel free to ask.


Search strategy:

Google search on: capital gains tax house sale
://www.google.com/search?q=capital+gains+tax+house+sale

Google search on: "rollover replacement"
://www.google.com/search?q=%22rollover+replacement%22

Referenced the IRS website.
http://www.irs.gov/

Referenced the CFTB website.
http://www.ftb.ca.gov/

Looking Forward, denco-ga - Google Answers Researcher

Very informative answer and just what I needed.

The 500K shielding figure comes from people just flipping the house,
taking the money, and running.

As long as your new house is equal in price or higher than that of
your old house, and you roll over all the proceeds into the new house,
you're good to go.

I believe the above is correct, but you must note the disclaimer
below:  nothing posted here is a substitute for informed professional
advice.

You will owe tax on the capital gain.  You had it right - from the
sales price subtract the adjusted cost basis (original cost +
improvements) and then subtract the $500,000 exemption (provided you
lived in the house two of the last five years.  You will owe tax on
the remaining amount.

That rollover into the new house to shield the profit was part of the
old tax law which was changed over 10 years ago.

Glad to have been of service, and thanks for the 5 star rating, fragrantgas-ga.

Looking Forward, denco-ga - Google Answers Researcher