Home Sale Tax Exclusion. Everything you Need to Know.
What Is A Home Sale Tax Exclusion?
The Internal Revenue Code Section 121 or better know as the Home Sale Exclusion is the potential qualification by a tax payer to exclude up to $250,000 of the gains after the sale of their main home. Or if married and filling a joint return, up to $500,000 from the gains.
So what are capital gains?
The IRS, in simple terms, considers capital gains as the difference between how much you paid for the home (also other assets like bonds & stocks, cars, furniture, etc) and the amount you actually sell it for.
So, if you bought your main home for $100,000 and sold it a few years later for $400,000, your capital gains would be $300,000. If you’re single, you could potentially exclude up to $250,000, or up to the entire $300,000 amount if married and filing a joint return.
How To Qualify For A Home Sale Tax ExclusionIn order to qualify for the exclusion there are three rules you must meet and be aware of.
1. The Two-Year Ownership Rule
You must have owned the residence for a minimum of two years out of the five years prior to the date you will sell the home.
2. Use Of The Residence
You must have used the home as your primary residence for at least two years out of the five years prior to the date you will sell the home.
Note that these two years don’t have to be continuous, or have to be the two years immediately before you sell the house.
For example, if you used the house as your primary residence for two years, then you moved out and rented it out for three years (no longer than three years), you can still exclude the gains when you sell the home.
Note that in the example above, you have to sell the home before the three years of you being out of the home are up. If you wait longer than the three years, it would break the five-year prior to the sale rule.
The third rule to be aware of in order to qualify for the Home Sale Tax Exclusion, is the timing in which you have claimed the exclusion from the sale of another property.
If you’re looking to sell a residence, and you meet the previous two rules but you have claimed this exclusion in the last two years on the sale of another home, you will not be able to qualify.
Simply, you can only apply this rule two years after the last time you applied the home exclusion.
If you’re married, you can qualify to exclude $500,000 of the capital gains from your income.
However, in order to qualify you must meet all of the below:
1. File a joint tax return.
2. Either you or your spouse must meet the ownership rule mentioned above. You will want to know that only one spouse needs to meet this rule.
3. Both you and your spouse must meet the use of residence rule mentioned above.
If you were given ownership of the home after a divorce settlement, the time your former spouse owned the home can count towards your time you have owned the home in order to pass the two-year ownership rule.
How To Report The SaleYou should always work with your CPA or tax professional in order to report your taxes accurately and avoid any potential audits. After you have sold the home, the IRS notes that you should always report the sale, whether it is excludable or not. In order to report the sale, if you received an income-reporting document such as Form 1099-S, you must still report the sale of the home, even if the capital gain can be excluded. Use Form 1040, Schedule D, Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets when required to report the home sale. You can also refer to Publication 523 on the IRS website for the rules on reporting the sale of the home.
We hope this article has helped you and please share or leave us a comment, we’d love to hear from you.
Until next time!
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