Selling Your Home? Understand the Home Sale Exemption
Sky-high demand for homes, driven in large part by rock-bottom interest rates, has created a seller’s market. If you’re thinking about selling your home, it’s important to determine whether you qualify for the home sale exemption. The exemption is one of the most generous tax breaks in the tax code, so be sure to review its requirements before you sell.
Exemption requirements
Ordinarily, when you sell real estate or other capital assets that you’ve owned for more than one year, your profit is taxable at long-term capital gains rates of 15% or 20%, depending on your tax bracket. High-income taxpayers may also be subject to an additional 3.8% net investment income (NII) tax. If you’re selling your principal residence, however, the home sale exemption may allow you to avoid tax on up to $250,000 in profit for single filers and up to $500,000 for married couples filing jointly.
Don’t assume that you’re eligible for this tax break just because you’re selling your principal residence. If you’re a single filer, to qualify for the exemption, you must have owned and used the home as your principal residence for at least 24 months of the five-year period ending on the sale date.
If you’re married filing jointly, then both you and your spouse must have lived in the home for 24 months of the preceding five years and at least one of you must have owned it for 24 months of the preceding five years. Special eligibility rules apply to people who become unable to care for themselves, couples who divorce or separate, military personnel, and widowed taxpayers.
Limitations apply
You can’t use the exemption more than once in a two-year period, even if you otherwise meet the requirements. Also, if you convert an ineligible residence into a principal residence and live in it for 24 months or more, only a portion of your gain will qualify for the exemption.
For example, John is single and has owned a home for five years, using it as a vacation home for the first three years and as his principal residence for the last two. If he sells the home for a $300,000 gain, only 40% of his gain ($120,000) qualifies for the exemption, and the remaining $180,000 is taxable. (Note: Nonqualified use prior to 2009 doesn’t reduce the exemption).
Partial exemption
What if you sell your home before you meet the 24-month threshold due to a work- or health-related move, or certain other unforeseen circumstances? You may qualify for a partial exemption.
For example, Paul and Linda bought a home in California for $1 million. One year later, Paul’s employer transferred him to its New York office, so the couple sold the home for $1.2 million. Although Paul and Linda didn’t meet the 24-month threshold because they sold the home due to a work-related move, they qualified for a partial exemption of 12 months/24 months, or 50%. Note that the 50% reduction applied to the exemption, not to the couple’s gain. Thus, their exemption was reduced to 50% of $500,000, or $250,000, which shielded their entire $200,000 gain from tax.
Crunch the numbers
Before you sell your principal residence, determine the amount of your home sale exemption and your expected gain (selling price less adjusted cost basis). Keep in mind that your cost basis is increased by the cost of certain improvements and other expenses, which in turn reduces your gain. Also, be aware that capital gains attributable to depreciation deductions (for a home office, for example) will be taxable regardless of the home sale exemption.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
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