Federal tax laws allow each individual taxpayer to exclude up to $250,000 of gain from the sale of his/her main home, if he/she meets certain ownership and occupancy requirements. (A married couple that meets the qualifications can exclude up to $500,000.) If an individual/couple is unable to exclude all or part of the gain, then the gain is taxable as a capital gain in the year of sale.
Unless they meet the reduced exclusion qualifications, taxpayers must meet the ownership and use tests in order to qualify for exclusion of gain. This means that during the five-year period ending on the date of the sale, taxpayers must have:
- Owned the home for at least two years (if a joint return only one spouse need meet the ownership test), and
- Except for short temporary absences, lived in (used) the home as their main home for at least two years.
A taxpayer who meets the ownership and occupancy tests can exclude the entire gain on the sale of his/her main home up to $250,000, provided gain has not been excluded on a sale of another home within two years of the sale of the current home. The maximum exclusion amount is $500,000 if all the following are true:
- The taxpayers are married and file a joint return for the year. (Key: Must file joint in 2015)
- Either the taxpayer or the taxpayer’s spouse meets the ownership test.
- Both the taxpayer and taxpayer’s spouse meet the use test.
- During the two-year period ending on the date of the sale, neither the taxpayer nor the taxpayer’s spouse excluded gain from the sale of another home.
Home Acquired by Tax-Deferred Exchange
If the home was originally acquired via a Sec 1031 tax-free exchange, the home must be owned for a minimum of five years before a home-sale gain exclusion can be utilized, provided the taxpayer also meets the 2-year use test.
A taxpayer who does not qualify for the full exclusion may still qualify to exclude a reduced amount if the taxpayer(s) did not meet the ownership and use tests, or the exclusion was disallowed because of the once every two-year rule, but sold the home due to:
- A change in place of employment; (Used by most agent to maximize exclusion – Consult with us)
- Health; or
- Unforeseen circumstances, to the extent provided in IRS regulations.
Rental Converted to a Home
The sale of residential rental property is governed by an entirely different set of tax rules than those applying to an individual’s main home. However, had the home also been used as the taxpayer’s main home either before or after being used as a rental, then it can still qualify for the home sale exclusion if it meets the ownership and use tests ($250k or $500k). This can provide a significant tax benefit for individuals who carefully plan their sales. As with the home office, the rental’s depreciation is not subject to exclusion, and all or part may be taxable to the extent of the sale profit (gain).
However, if the home was previously used as other than a taxpayer’s main home (non-qualified use), for example, as a second home or a rental, and converted to a personal residence after December 31, 2008, the portion of the prorated gain attributable to the non-qualified use will not qualify for the home gain exclusion.
Taxpayers contemplating such a tax strategy should consult with this office in advance to verify qualifications and determine the tax implications, including depreciation recapture.
Give us a call at 301-962-1700 to assist you and your real estate client make the right choice when selling a home.
Read more and download a free Selling Your Home Tax Guide