Primary Home Sale Gain Exclusion
Under section 121 of the Internal Revenue Code, up to $250,000 ($500,000 for married couples filing jointly) of appreciation that a taxpayer receives on the sale of their primary home may be exempt from income taxes.
Qualifying for the Exclusion
The taxpayer's home must be their primary home or the one in which they live the majority of the time. A taxpayer who rents the home to others or uses it for business may be able to exclude the gain from its sale, but only if the taxpayer meets both the ownership test and the use test explained below. The taxpayer cannot exclude a part of the gain that equals the depreciation deducted on the rental property.
To qualify for the $250,000 (or $500,000) exclusion, a taxpayer must meet both an "ownership test" and a "use test." The taxpayer must have (1) owned the home as the taxpayer's primary home for a period totaling two years out of the five years ending on the date of sale, and (2) lived in the home for at least two years out of the five years ending on the date of the sale. The ownership test and the use test can be satisfied during different two-year periods.
The taxpayer generally may not exclude the gain if the taxpayer excluded gain from the sale of another home within two years before the sale.
A taxpayer may elect to suspend the five-year tests for up to 10 years if the taxpayer or the taxpayer's spouse is on "qualified official extended duty" in the Uniformed Services, the Foreign Service, or the intelligence community. "Qualified extended duty" means that the taxpayer is at a duty station at least 50 miles from the taxpayer's primary home, or resides under government orders in government housing for more than 90 days or for an indefinite period.
No deduction is allowed for a loss on the sale of a primary home.
The taxpayer must report the sale to the IRS in two situations:
- The taxpayer cannot exclude all of the capital gain (i.e., some or all of it is taxable); or
- The taxpayer has a loss and received a Form 1099-S or other information statement reflecting the sale.
Otherwise, the taxpayer does not need to report the gain.
The sale generally should be reported on Form 8949 and Form 1040, Schedule D. However, if the sales contract provides that some or all of the sales price is to be paid in a later year, the sale should be reported under the installment method unless the taxpayer elects out of that method.
Different rules apply if you are selling your second home or inherited home or rental property. In the case of a vacation home, it is considered a capitol asset. You must use a 1040 with a Schedule D to report the “Capital Gains and Losses” and a Form 8949. Land and timber sales are both considered capital assets and as such a Schedule D must be used to report gains or losses on those transactions as well.
Sales of rental properties fall under the Form 4797, Sales of Business Property.
Checklist for Selling Your Home
After a home sells, homeowners should receive a seller's disclosure at the closing. This disclosure will list some of the costs which they are eligible to deduct from any gain. If the homeowner also made major improvements to the home, and they saved their receipts, they may be eligible to deduct these as well. The following is a list of some of the most common deductions and exclusions used to off-set capital gains from the sale of a home.
The best and most significant tax break most people get is the gain exclusion from their taxes. As covered above, if you're single, and your profit is $250,000 or less on the sale of your home, you're exempt from paying taxes on the amount, and you also don't have to report it. Married couples are exempt from reporting up to $500,000 in profit on the sale of a home. The only qualifying standard is that you have to have owned and lived in the home for at least two out of the past five years. Note that you may qualify to exclude part of your gain if you sold your home at a profit greater than the excluded amounts but were under certain unforeseen circumstances such as divorce, illness, or job relocation.
If you bought your home before October 1, 2015, you received a HUD-1 Settlement Statement showing all your closing charges. Anytime after that, both buyers and sellers receive a list of their closing costs in a form known as a closing disclosure. Keep your seller's closing disclosure for accurate amounts of the following expenses to deduct on your taxes:
- Real estate commission
- Closing agent's fees
- Other legal fees
- Title insurance
- Inspection costs
- Escrow fees
You may also get a tax break on your share of the property taxes paid on the home for the year. The prorated amount is also listed on the closing disclosure.
You might be able to deduct your moving expenses if you sold the house to move to a new city for a new job. If this is the case, you may be able to deduct the cost of supplies such as boxes, bubble wrap, and tape, rental of a moving van, and travel to your new home. It's vitally important to keep your receipts in a safe place so you can deduct the expenses when filing your taxes.
You usually can't deduct improvements you make while you're living in your home, but the IRS lets you deduct some costs if you make them specifically to help sell the home. Typical improvements that help homes sell include a new HVAC system, a new roof, or upgraded plumbing. These expenses are considered selling costs, and you may claim them within 90 days of closing with the appropriate documentation.
Read more on the tax benefits of homeownership.