The recent hot real estate market has created opportunities for many taxpayers.  If the value of your primary residence has increased significantly over the last few years, you may be able to take advantage of a generous tax benefit.  If you meet both tests discussed below, the IRS allows an exclusion of the gain on the sale of your primary residence: $250,000 for single filers or $500,000 for married filing jointly.

In order to exclude the gain on the sale of your primary residence from your taxable income, you must pass two tests: ownership and use.  The ownership test requires that you own the home for at least two of the last five years, ending on the date of sale.  The use test requires that you live in the home as your primary residence for at least two of the last five years, ending on the date of sale.  It is important to note that the ownership and use periods don’t have to be continuous.

The following examples will help illustrate the home sale exclusion.

Example 1

John, a single taxpayer, purchased a home in the year 2000 for $100,000.  John lived in and used this as his primary residence until he sold the home in 2023 for $325,000.  Since John’s filing status is single, he can exclude up to $250,000 of the gain on the sale of this home.  John’s total gain on the sale is $225,000 ($325,000 sales price less $100,000 purchase price).  Therefore, 100% of the gain can be excluded since the total gain is under the $250,000 allowance threshold.

Now let’s assume the same facts as above, except this time John sells his home for $400,000.  In this new scenario, John can exclude $250,000 of the $300,000 total gain.  The remaining $50,000 of gain will be taxable to John in the form of a long-term taxable gain.

Example 2

John and Sarah are married and file a joint tax return.  John purchased a home in the year 2000 for $150,000, before he was married to Sarah.  John married Sarah in 2005 and the two have lived in the home ever since.  In 2023, the couple sells their home for $550,000.  The entire gain of $400,000 can be excluded from taxable income on their married filing joint return since it does not exceed the allowance threshold for their filing status.

Example 3

John and Sara are married and file a joint tax return.  In January of 2021, John and Sara purchased a home for $350,000.  In August of 2022, John and Sarah sell their home for $450,000.  The entire gain will be included in income by John and Sarah on their 2022 income tax return because they did not meet the ownership test.

Reporting the sale of your personal residence

Taxpayers should understand when it is necessary to report the sale of their home on their tax return.  If you did not receive a form 1099-S at closing from the settlement firm and the total gain is less than the exclusion amount, you do not need to report the sale of your home on your income tax return.  If you received a Form 1099-S, then you will need to report the sale of your home on Form 8949.  If you otherwise meet the exclusion, then no gain will be reported.  If you have a gain in excess of the exclusion, you will report the difference as a long-term capital gain.  Current capital gain rates range from 0 – 23.8% depending on your tax bracket.

If you sell your personal residence for a loss, that loss is non-deductible for income tax purposes.  You do not need to report this transaction on your income tax return unless you received a Form 1099-S.

Reduced gain exclusion

Under certain circumstances, you may qualify for a reduced gain exclusion if you don’t meet the two-year test requirement.  Circumstances include if:

  • You relocated for new employment and your new job is more than 50 miles from the home, and the change of employment occurred while you owned and used the home as your primary residence
  • You received a medical diagnosis or a doctor recommendation due to certain health conditions or necessary care
  • An unforeseeable event (see IRS publication 523)

Business use of your main home

If you used your primary residence for business or rental but otherwise meet the tests above, you might be able to exclude the gain from the sale of the home without needing to allocate the business portion of the gain.  However, it’s important to note that you’ll still need to account for any  depreciation allowed or allowable that you’ve claimed since May 6, 1997.  You can’t exclude a gain that’s equal to any depreciation deductions you’ve claimed during this time.  Other restrictions may apply for vacation homes converted to a primary residence.

Contact the professionals at Gilliam Bell Moser for more information.