The National Association of Realtors recently reported that the median sales price of an existing single family home was around $180,000 in late 2012. That’s down from the peak years of 2005–2007, when such prices were near $220,000 but still up from 2002, when the median price was $167,600. Therefore, if you sell a home you’ve owned for 10 years or more, you may well have a gain on the sale. (The same might be true if you sell a house bought in late 2009 or early 2010, the low point of the recent cycle.) Thanks to some of the most generous breaks in the tax code, you may owe little or no tax on such a gain. In brief, you can exclude up to $250,000 of housing profits from capital gains tax, or up to $500,000 of gains if you are married and file a joint tax return. However, you must pass several tests in order to qualify for either tax exclusion.
Owned and occupied
The $250,000 and $500,000 tax breaks apply only to sales of your principal residence. You can’t claim these exclusions for sale of a vacation home or an investment property. What’s more, you must have owned and used the home as your primary residence for at least two of the five years before the sale. (Some exceptions apply in cases of poor health, job changes, and unforeseen circumstances.) The two years do not have to be an unbroken time period. Example 1: Pete Roberts bought a house for $200,000 in April 2008. He moved in right away and lived there until February 2009. At that point, Pete took a new job and relocated to a different state. He put his home on the market but was not able to sell it.
Pete’s new job didn’t work out, so he moved back into his home in January 2011. On June 15, 2012, he sold the home for $250,000. In this scenario, the five-year period before the sale stretched from June 16, 2007, to June 15, 2012. Pete had owned the home since April 2008, so he exceeded the two-year requirement.
During the five-year period, Pete lived in the house as his main home for 10 months (April 2008 to February 2009) and for 17 months ( January 2011 to June 2012). Therefore, he passed the residency requirement as well. Pete is able to exclude the $50,000 gain from tax because it is less than the $250,000 maximum exclusion.
The tax rules are more complicated if you sell a house that has had some business use. Example 2: Assume that Laura Martin has the same housing experience as Pete Roberts in example 1. However, when Laura moved out of her house for nearly two years, she rented it to a tenant. Then, Laura moved back into the house, sold it, and qualified under both two year tests. Again, Laura can exclude up to $250,000 of gain on the house sale. However, Laura cannot exclude the part of the gain equal to the depreciation she claimed while her house was rental property. If you are in this type of situation, our office can help you calculate the taxable gain you will need to report.
Another two-year rule
You can claim the $250,000 or $500,000 tax exclusion multiple times, without limit. If you claim either of these exclusions, though, you generally cannot claim another one within two years. In the previous examples, both Laura Martin and Pete Roberts claim exclusions for a house sale on June 15, 2012.
Therefore, if either of them sells a house before June 16, 2014, he or she cannot claim any exclusion on that sale.
Married couples can exclude up to $500,000 of gain from the sale of their principal residence as long as either spouse meets the ownership requirement, both spouses meet the use requirement, and neither spouse is ineligible to take the exclusion because they had already excluded the gain on a different primary residence during the two-year period ending with the date of the current sale.