If you’re thinking about selling your home, it’s important to determine whether you qualify for the home sale gain exclusion. The exclusion is one of the most generous tax breaks in the tax code, so review its requirements before you sell.
Home Sale Gain Exclusion Requirements
When you sell real estate or other capital assets you’ve owned for more than a year, your profit is typically taxed at long-term capital gains rates of 15% or 20% (according to your tax bracket). Additionally, there may be an additional 3.8% net investment income (NII) tax imposed on high-income earners. However, if you’re selling your primary residence, you could be able to avoid taxes on up to $250,000 in profit for single filers (up to $500,000 for married couples filing jointly) thanks to the home sale gain exclusion.
Just because you’re selling your primary residence doesn’t mean you qualify for this tax reduction. If you’re a single filer, you must have owned and utilized the house as your primary residence for at least 24 months during the five years preceding the sale date in order to be eligible for the exception.
If you are married and filing jointly, both of you must have made the property your primary residence for 24 months out of the previous five years, and at least one of you must have been the property’s owner for the preceding five years. For those who lose the ability to care for themselves, divorcing or separating couples, service members, and widowed taxpayers, there are special eligibility requirements.
Some Conditions Apply
Even if you meet the other qualifications, you can only use the exception once every two years. Additionally, only a portion of your gain will be eligible for the exclusion if you convert an ineligible residence into a principal residence and reside in it for 24 months or longer.
For instance, John, a single man, has owned a house for five years, using the first three of those years as a vacation home and the last two as his primary residence. Only 40% of his gain, or $120,000, qualifies for the deduction if he sells the house for a $300,000 gain; the remaining $180,000 is subject to tax. (Note that earlier nonqualified use prior to 2009 does not reduce the exclusion.)
What happens if you have to move because of your job or health, or if there are other unforeseeable reasons why you have to sell your house before the 24-month mark? You might be eligible for a partial exclusion.
For instance, Paul and Linda spent $1 million on a house in California. The couple sold the house for $1.2 million after Paul’s work moved him to its New York headquarters a year later. Paul and Linda did not meet the 24-month requirement, but because they moved for work, they were eligible for a partial exclusion of 12 months divided by 24 months, or 50%.
Keep in mind that the exclusion, not the couple’s gain, was subject to the 50% decrease. As a result, their exclusion was reduced to 50% of $500,000, or $250,000, which shielded their entire $200,000 gain from tax.
Calculate the Numbers
Determine the amount of your home sale gain exclusion and your anticipated gain before selling your primary house (selling price less adjusted cost basis). Remember that the cost of certain renovations and other expenses increases your cost basis, lowering your gain in the process. Be advised that regardless of the house sale gain exclusion, capital gains related to depreciation deductions (for a home office, for example) will be subject to taxation. If you have questions about the home sale gain exclusion, contact us today.