If you sell your home (a capital asset) and make a profit (gain), you may be able to exclude that profit from your taxable income.
The Taxpayer Relief Act of 1997 changed the tax laws concerning capital gains on primary residences. In years past, when you sold your home you could delay paying tax on your profit if you purchased another home within two years of selling. (There were also restrictions on the price of the home you had to buy.)
Today, you don’t have to purchase another home to receive capital gains tax relief and you only pay taxes on any gains over $250,000 ($500,000, if married filing jointly) as long as you have owned and lived in the home for a minimum of two years (those two years do not need to be consecutive) in the 5 years prior to the sale of the house. In other words, the home must have been your principal residence for at least 24 months in that 5-year period.
You can use this 2-out-of-5 year rule to exclude your profits each time you sell or exchange your main home. Generally, you can claim the exclusion only once every two years. Some exceptions do apply.
Here’s how the IRS recommends figuring the gain (or loss) on the sale of your primary home:
- Subtract your expenses from the selling price to obtain the realized amount. Expenses typically include:
- Advertising fees,
- Legal fees, and
- Loan charges, such as points.
- Subtract the adjusted basis you made to the basis of your home from the realized amount to get the gain (or loss). (The basis is the amount you paid if you bought it or built it.)
According to the Internal Revenue Service (IRS), you do not have to report the sale of your home on your tax return unless:
- You have a gain and you do not qualify to exclude all of it, or
- You have a gain and choose not to exclude it.
Otherwise, you must report the gain on Form 1040, Schedule D.
Exceptions to the 2 out of 5 Year Rule
If you lived in your home less than 24 months, you may be able to exclude a portion of the gain. Exceptions are allowed if you sold your house because the location of your job changed, because of health concerns, or for some other unforeseen circumstance.
Change in the Location of Your Job
If you lived in your house for less than two years, you can exclude a part of your gain on the sale of your house if your work location has changed. This exception would apply if you started a new job, or if you are moved to a new location with your employer.
If you are selling your house for medical or health reasons, be ready to document those reasons with a letter from your physician. Such a letter does not need to be filed with your tax return. Instead, keep the documentation in your personal records just in case the IRS wants further information.
If you are selling your house because of unforeseen circumstances, be ready to document what those reasons are. IRS Publication 523 defines an unforeseen circumstance as “the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.” The IRS has given specific examples of unforeseen circumstances:
- natural disasters,
- acts of war,
- acts of terrorism,
- change in employment or unemployment that left you unable to meet basic living expenses,
- separation, or
- multiple births from the same pregnancy.
You can exclude a portion of your gain if you are selling your home and lived there less than 2 years and you meet one of the three exceptions. You calculate your partial exclusion based on the amount of time you actually lived in your home.
Count the number of months you actually lived in your home. Then divide that number by 24. Then multiply this ratio by $250,000 (if unmarried) or by $500,000 (if married). The result is the amount of gain you can exclude from your taxable income.
For example: you lived in your home for 12 months, and then sold the home because your employer asked you to relocate to a different office. You are an unmarried person. You calculate your partial exclusion: 12 months divided by 24 month (for a ratio of .50) times your maximum exclusion of $250,000. The result: you can exclude up to $125,000 in gain. If your gain is more than $125,000, you include only the amount over $125,000 as taxable income. If your gain is less than $125,000, then your gain can be excluded from your taxable income.
Loss on the Sale of a Home
You cannot deduct a loss from the sale of your main home.
As with any tax information, your personal situation (including such things as divorce) can have major tax implications. And since IRS tax rules change often, you’ll want to be sure to consult with a qualified tax specialist.
Disclaimer: These are general guidelines and provided for information only. Other IRS rules may apply. Consult with your accountant, CPA or tax attorney for professional advice.
If you, or someone you know is considering Buying or Selling a Home in Columbus, Ohio please contact The Opland Group. We offer professional real estate advice and look forward to helping you achieve your real estate goals!
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