What is the best tax break available to John and Jane Taxpayer? If they're homeowners, it's selling their home. When you sell your primary residence, you can make up to $250,000 in profit if you're single, $500,000 if you're married and not owe any capital gains tax. Here are some specifics:
Ownership and use tests. To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
- Owned the home for at least two years (the ownership test).
- Lived in the home as your main residence for at least two years (the use test).
- You can claim the exclusion only once every two years.
Calculating Your Cost Basis. The formula for calculating the gain or loss of your home involves subtracting your cost basis from your selling price. The cost basis includes your purchase price, initial closing costs, and all home improvements; to this amount add all selling costs. Subtract this cost-basis amount from the selling price. This is your taxable gain or loss.
Gain. If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return). Any gains over these thresholds are reported on Form 1040, Schedule D. If you owned your home for more than one year, the gain is reported as a long-term gain.
Loss. You cannot deduct a loss from the sale of your main home.
Partial exclusion. Even if you don't meet all the home-sale exclusion tests, your tax break might not be totally lost. When an owner sells his house because of special conditions, such as change in health, employment or unforeseen circumstances, he's eligible for a prorated tax-free gain.
For example: Single taxpayer lived in his home for 12 months and then sold the home because his employer asked him to relocate to a different office. You calculate your partial exclusion: 12 months divided by 24 months (for a ratio of .50) times your maximum exclusion of $250,000. The result: you can exclude up to $125,000. If your gain is more than $125,000, you include only the amount over $125,000 as taxable income.
Reporting the Sale. You generally do not need to report your home sale on your income tax return, as long as you did not receive a Form 1099-S, Proceeds from Sale of Real Estate Transactions, from the real-estate closing agent. To avoid getting this form, you must certify that you meet the ownership, use, and timing tests that were noted earlier.
Surviving-spouse rules. Surviving spouses have a special provision: If they sell their residence within two years of their spouse's death, the $500,000 exclusion will be retained although they are probably filing single or head of household the following years.
The new 3.8-percent tax. Since 2013, a new 3.8-percent tax on net investment income from couples with adjusted gross income above $250,000 ($200,000 for singles). In cases where the gain is greater than the home's exclusion amount of $250,000/$500,000, the tax will affect only the amount above this benefit.
More Than One Home. If you have more than one home, you can exclude gains only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.
For additional information, refer to IRS Publication 523, "Selling Your Home."
Barry Lisak is an IRS Enrolled Agent, meaning that he has passed special U.S. Treasury Department exams that qualify him to represent clients dealing with audits or tax-resolution cases. Any questions can be directed to him at (516) TAX-SAVE, or email@example.com.
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