Michael Lodge – Tax Tip 2017
Here’s the most important thing you need to know: To qualify for the $250,000/$500,000 home sale exclusion, you must own and occupy the home as your principal residence for at least two years before you sell it. Your home can be a house, apartment, condominium, stock-cooperative, or mobile home fixed to land.
If you meet all the requirements for the exclusion, you can take the $250,000/$500,000 exclusion any number of times. But you may not use it more than once every two years.
The two-year rule is really quite generous, since most people live in their home at least that long before they sell it. (On average, Americans move once every seven years.) By wisely using the exclusion, you can buy and sell many homes over the years and avoid any income taxes on your profits.
One aspect of the exclusion that can be confusing is that ownership and use of the home don’t need to occur at the same time. As long as you have at least two years of ownership and two years of use during the five years before you sell the home, the ownership and use can occur at different times. The rule is most important for renters who purchase their rental apartments or rental homes. The time that a purchaser lives in the home as a renter counts as use of the home for purposes of the exclusion, even though the renter didn’t own the home at the time.
If You are Not Living in the Home
To qualify for the home sale exclusion, you don’t have to be living in the house at the time you sell it. Your two years of ownership and use may occur anytime during the five years before the date of the sale. This means, for example, that you can move out of the house for up to three years and still qualify for the exclusion.
This rule has a very practical application: It means you may rent out your home for up to three years prior to the sale and still qualify for the exclusion. Be sure to keep track of this time period and sell the house before it runs out.
The Home Must Be Your Principal Residence
To qualify for the exclusion, you must have used the home you sell as your principal residence for at least two of the five years prior to the sale. Your principal residence is the place where you (and your spouse if you’re filing jointly and claiming the $500,000 exclusion for couples) live.
You don’t have to spend every minute in your home for it to be your principal residence. Short absences are permitted—for example, you can take a two month vacation away from home and count that time as use. However, long absences are not permitted. For example, a professor who is away from home for a whole year while on sabbatical cannot count that year as use for purposes of the exclusion.
You can only have one principal residence at a time. If you live in more than one place—for example, you have two homes—the property you use the majority of the time during the year will ordinarily be your principal residence for that year.
If you have a second home or vacation home that has substantially appreciated in value since you bought it, you’ll be able to use the exclusion when you sell it if you use that home as your principal home for at least two years before the sale.
$500,000 Exclusion for Married Couples
There are certain additional requirements you must meet to qualify for the $500,000 exclusion. Namely, you must be able to show that all of the following are true:
- you are married and file a joint return for the year
- either you or your spouse meets the ownership test
- both you and your spouse meet the use test, and
- during the 2-year period ending on the date of the sale, neither you or your spouse excluded gain from the sale of another home.
If either spouse does not satisfy all these requirements, the exclusion is figured separately for each spouse as if they were not married. This means they can each qualify for up to a $250,000 exclusion. For this purpose, each spouse is treated as owning the property during the period that either spouse owned the property. For joint owners who are not married, up to $250,000 of gain is tax free for each qualifying owner.
IRS RULES BELOW:
If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income. You may qualify to exclude up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home, provides rules and worksheets. Topic 409 covers general capital gain and loss information.
Qualifying for the Exclusion
In general, to qualify for the exclusion, you must meet both the ownership test and the use test. You’re eligible for the Section 121 exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. Generally, you’re not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home. Refer to Publication 523 for the complete eligibility requirements, limitations on the exclusion amount, and exceptions to the two-year rule.
Reporting the Sale
If you receive an informational income-reporting document such as Form 1099-S (PDF), Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable. Additionally, you must report the sale of the home if you can’t exclude all of your capital gain from income. Use Form 1040, Schedule D (PDF), Capital Gains and Losses, and Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, when required to report the home sale. Refer to Publication 523 for the rules on reporting your sale on your income tax return.
Suspension of the Five-Year Test Period
If you or your spouse are on qualified official extended duty in the Uniformed Services, the Foreign Service or the intelligence community, you may elect to suspend the five-year test period for up to 10 years. You’re on qualified official extended duty if for more than 90 days or for an indefinite period, you’re:
- At a duty station that’s at least 50 miles from your main home, or
- Residing under government orders in government housing.
Refer to Publication 523 for more information about this special rule to suspend the 5-year test.
If you sold your home under a contract that provides for all or part of the selling price to be paid in a later year, you made an installment sale. If you have an installment sale, report the sale under the installment method unless you elect out. Even if you use the installment method to defer some of the gain, the exclusion of gain under section 121 remains available. Refer to Publication 537, Installment Sales, Form 6252 (PDF), Installment Sale Income, and Topic 705, Installment Sales, for more information on installment sales.