Sale of Your Personal, Principle Residence – Part 1 – The Home Sale Exclusion
If you are married and file a joint tax return, you may be able to exclude up to $500,000 of gain on the sale of your personal residence. If you are single or married and filing a separate return you may be eligible to exclude up to $250,000 on your return.
This is one of the greatest financial advantages of home ownership. It was implemented under the Taxpayer Relief Act of 1997. As with all matters related to the tax law, taking full advantage of this exclusion requires careful planning and timing. We always recommend that you discuss your particular situation with your tax professional.
Measuring a Capital Gain
First you must determine if you made a profit on the sale of your house. Selling price less adjusted basis equals gain (or loss) on the transaction. Adjusted basis includes the original purchase price of your house, the cost of any improvements made over the years and expenses related to the sale of your house.
The Calculation:
Selling price of your home
Less:
Original purchase price
Improvements
Selling costs
Purchase expenses
Plus:
Depreciation
Equals:
Gain (or loss)
Now, if you made a profit on the sale of your home and have a taxable capital gain, you must determine if you meet the various requirements to qualify for the exclusion.
The Qualification Rules
Qualifying for the $250,000 Exclusion –
To qualify for the exclusion, you must meet ALL of the following rules:
1. Only one home sale can be excluded in any two-year period.
We’ll start with an easy one. You can get the full exclusion on only one home sale every two years.
OK, perhaps this isn’t so easy. As with most tax regulations, there are some exceptions to the general rule. Even if you sell your home before the two-year period is up, these exceptions may allow you to qualify for some of the exclusion. These exceptions are discussed below.
2. The home you sell must be your “principle residence”.
For most of us, this is a simple one. This is the place you live – home, condo or houseboat.
But what if you own more than one home? Normally, your principle residence is the one where you live most of the time. The IRS provides the following example:
You own and live in a house in the city. You also own a beach house, which you use only during the summer months.The house in the city is your main home.
(For further reading on this topic, you may want to look at some of the excellent documents on the IRS website including Publication 523 – Selling Your Home .)
But what if you used two homes about the same amount of time?
Other factors may be used to determine which is your principle residence. They include:
- Your place of employment
- The location of your family members’ main home
- Your mailing address for bills and correspondence
- The address listed on your:
Federal and state tax returns
Driver’s license
Car registration
Voter registration card
- The location of the banks you use
- The location of recreational clubs and religious organizations of which you are a member
3. You must have owned the home for at least two years of the five years before the date of the sale. This is the ownership test.
Example: Lizinka purchased her home on January 1, 2009 and decides to sell it on May 1, 2010. She is not eligible for the exclusion because she has owned it less than two years.
4. You must have used the home as your principal residence for at least two of the five years before the date of the sale. This is the use test.
Example: Dick purchased his home on June 1, 2004 and lived in it until July 1, 2006. He then moved to Richmond and rented his home to his stepson Campbell until he sold it on January 31, 2010. Dick is eligible for the exclusion because he both owned and used the home as his primary residence for two of the five years before the date of the sale.
Qualifying for the $500,000 Exclusion –
To qualify for the $500,000 exclusion available for married taxpayers only, there are a few additional requirements:
- You are married and file a joint return for the year.
- Either you or your spouse meets the ownership test.
- Both you and your spouse meet the use test.
- During the two-year period ending the date of the sale, neither you nor your spouse excluded gain from the sale of another home.
If any of these requirements are not met, you will not be eligible for the $500,000 exclusion, but may qualify individually for the $250,000 exclusion.
Example: Dick and Lizinka bought their primary residence on February 1, 2004. They lived in the house until March 1, 2005 when they went on an around the world cruise for three months. They sold their house on February 1, 2007. Dick and Lizinka would be able to exclude any capital gain on the sale. They owned the house for two years and short absences are OK.
Example: Facts are the same as above except that Dick moved to New Mexico on business for one year. In this case, they would not be able to take the exclusion because both have to meet the use test. Extended absences are not permitted. They may be able to separately meet the tests for the $250,000 exclusion.
Exceptions to the two-year rule –
As we mentioned above, you may be able to qualify for part of the exclusion if you meet one of the following exceptions.
1) Change your place of employment: If you have to move due to a change in jobs before you meet the two-year tests, you may qualify for part of the exclusion whether the change was voluntary or involuntary.
2) Change in health: If a change in residence is due to a disease, illness or injury of a “qualified person” living in the household, you may qualify for the exclusion. This would include caring for a sick relative. Qualified persons include:
- Parent, grandparent, stepmother or stepfather.
- Child, grandchild, stepchild, adopted child, or eligible foster child.
- Brother, sister, stepbrother, stepsister, half-brother or half-sister.
- Mother-in-law, father-in-law, brother-in-law, sister-in-law, son-in-law or daughter-in-law.
- Uncle, aunt, nephew, niece or cousin.
- You or your spouse.
- A co-owner of the house
3) Unforeseen circumstances: If you change residences due to an event that could not have been anticipated before purchasing and occupying the residence, you may qualify for a partial exclusion. The IRS provides the following examples:
- An involuntary conversion of your home such as when you house is destroyed or condemned
- Natural or man-made disasters
- Acts of war
- Death, unemployment or change of employment for you, your spouse, a co-owner of the home or another person whose main home is the same as yours
- Divorce or legal separation
- Multiple births from the same pregnancy
How to Calculate the Reduced Exclusion:
If you are only eligible for part of the exclusion, use the following formula to calculate the amount of your exclusion:
Capital gains exclusion (either $500,000 or $250,000) X Number of days
The number of days will be the fewest number of days as per the following:
- The period of time you owned your home.
- The period of time you occupied your home.
- The period of time between the date you sold your previous home and the date of the sale of your current home.
You are RISKING your money!
As you can see, taking the home sale exclusion can get pretty complicated pretty quickly. Since $250,000 to $500,000 are at risk, it is important to know how to maximize your exclusion and minimize your taxes. We give all new clients a FREE ONE HOUR CONSULTATION to discuss there situation and help them determine the best tax strategy. Don’t risk losing money! Call one of our offices today!