These days, many homeowners are considering selling their homes to take advantage of the booming housing market. In deciding whether to put their house on the market, homeowners should understand the tax consequences of a sale. To do this, they need to determine whether they qualify for an exclusion from taxes for the sale, make the appropriate adjustments to their basis in the property, and calculate the amount of “gain” from a possible sale.
Determining whether an exclusion applies
While the sale of real property is a taxable event under the Internal Revenue Code, taxpayers may be able to exclude up to $500,000 of the gain realized from the sale of their principal residence.
To qualify for a principal residence exclusion, a taxpayer must have owned and used the property as their principal residence for a period that totals two or more years during the five-year period ending on the date of the sale. The two years do not need to be continuous.
A taxpayer can use an exclusion no more than once every two years. The exclusion is generally limited to $250,000 for single individuals and married individuals filing separately. Married couples filing jointly can exclude up to $500,000 if at least one spouse meets the ownership requirement, both spouses meet the use requirement, and neither spouse has used an exclusion within the past two years. If one of the spouses does not qualify, the other spouse generally remains eligible for an exclusion of up to $250,000.
Taxpayers may exclude a fraction of the amount if they fail to meet the ownership and use requirements due to a change in place of employment, health, or other unforeseen circumstances. Special rules apply in determining ownership and use for taxpayers who receive out-of-residence care, inherit property from a spouse, transfer property pursuant to a divorce, or dispose of property where the rollover rules applied. The exclusion rule also generally applies to the sale of a remainder interest in a principal residence, allowing taxpayers to retain a life estate in a home while selling the remainder interest.
