Are you planning to sell your home? If you make a profit on the sale, it may be subject to capital gains tax on your federal tax return. However, you may be eligible for a tax break called the capital gains exclusion if you meet certain requirements. Read on to learn more about avoiding (or at least minimizing) taxes owed on your capital gains.
What is capital gains tax?
When you sell an asset for more than you paid for it, the profit you make is referred to as a capital gain. Capital gains are often taxed in the context of investments (such as the sale of stocks or bonds) as well as the sale of tangible assets like real estate or motor vehicles. However, the IRS allows taxpayers to exclude a certain amount of capital gains from being taxed as long as certain requirements are met.
How can I qualify for the capital gains exclusion when I sell my home?
If you earn capital gains on the sale of your home, you may be able to exclude up to $250,000 (single filers) or $500,000 (married filing jointly) as long as you have owned and used your home as your principal residence for at least twenty-four months out of the five years prior to the date of sale. These twenty-four months are not required to have occurred consecutively.
However, if you have taken the capital gains exclusion for the sale of another home during the two-year period prior to selling your home, you are not eligible for the exclusion. You are also ineligible if you are subject to expatriate tax or bought the house through a like-kind exchange (trading one property for another, also known as a 1031 exchange) within the past five years.
I don’t meet the 24-month residence test due to extenuating circumstances. Can I still qualify for the maximum exclusion?
Taxpayers who do not meet the residence requirement may still be able to take the maximum capital gains exclusion depending on the situation.
Separation or Divorce
If you were separated or divorced prior to the sale of your home, you may still treat the home as your residence if you are a sole or joint owner and your spouse or former spouse uses the home as his or her main home in accordance with a divorce or separation agreement. If your home was transferred to you by a spouse or ex-spouse, you can count any time when your spouse owned the home as time when you owned it, but you must meet the residence requirement on your own.
If you are widowed and do not meet the ownership and residence requirements on your own, you may include the time that your late spouse owned and lived in the home to meet the requirements as long as you haven’t remarried at the time of sale. You may also be eligible to take a higher exclusion amount ($500,000 instead of $250,000) if the sale of your home takes place within two years of your spouse’s death and neither you nor your late spouse took the exclusion on another home sold during the two years prior to the current home sale.
Service, Intelligence, and Peace Corps Personnel
If you or your spouse are a member of the Uniformed Service, Foreign Service, or intelligence community in the United States, you may suspend the five-year test period for ownership and residence while on qualified official extended duty. This allows you to meet the 24-month residence test even if you didn’t actually live in your home for the full period of time due to your service. However, this period of suspension cannot exceed 10 years. You can only suspend the 5-year period for one property at a time.
Other potential exceptions to the eligibility test are included in IRS Publication 523, Selling Your Home. This publication also addresses certain unique circumstances in which the capital gains exclusion may be retroactively applied.
Can I qualify for a partial capital gains exclusion?
Even if you do not qualify for the maximum capital gains exclusion, you may be eligible for a partial exclusion if your home sale was necessitated by a change in workplace location, a health issue, or an unforeseeable event as defined by the IRS.
If you are in the process of selling your home or need guidance on the tax implications of a recent home sale, be sure to contact your local CPA.