Gain Exclusion on the Sale of Principal Residence

Before selling your home, it is imperative that you consider the tax ramifications associated with the sale. With proper tax planning, you can exclude all or a portion of any gain on the sale of your principal residence.

Taxpayers can exclude up to $250,000 of gain ($500,000 for married couples and certain surviving spouses) on the sale of their principal residence if they meet the following ownership, use and time tests:

  • Taxpayers must have owned and used the property sold as their principal residence for periods totaling two years out of the five-year period ending on the date of sale (the two years do not have to be consecutive); and
  • Taxpayers must have not used the gain exclusion within the two-year period ending on the date of sale.

If the taxpayer owns more than one home, the property used the majority of time generally is considered the principal residence; however other factors can be used to determine the principal residence including:

  • Taxpayer’s place of employment;
  • Taxpayer’s family’s place of abode;
  • Address listed on the taxpayer’s tax return, driver’s license, voter registration, etc.;
  • Taxpayer’s mailing address for bills;
  • Location of taxpayer’s bank; and
  • Location of religious organizations or recreational clubs with which the taxpayer is affiliated.

Married couples filing jointly in the year of the home sale are eligible for the exclusion if at least one spouse satisfies the ownership test, both spouses satisfy the use test, and neither spouse sold a home more than once every two years.

Surviving spouses can exclude up to $500,000 of gain if the sale occurs within two years of their spouse’s death and they are unmarried at the time of the sale.

If a taxpayer becomes physically or mentally incapable of self-care, the use test is modified. Periods of residence in a licensed-care facility count toward the use test if the individual occupied the principal residence for at least one year during the five-year period before the date the home is sold.

Members of the military or those in foreign or intelligence service can suspend the five-year period for both the ownership and use tests for up to 10 years when serving on qualified official extended duty.

Generally, gain exclusion on the sale of principal residence is automatic if the qualifications are met; however, taxpayers may elect to not apply the exclusion by reporting the gain. Electing out of the gain may be a good tax planning strategy if the gain is small and the taxpayer expects to sell another home at a larger gain within two years of the first sale.

Taxpayers who do not meet the ownership, use and time tests may still qualify for a reduced exclusion on the sale of their home if the primary reason for selling the home before those tests are met are related to:

  • Job relocation;
  • Health problems; or
  • Unforeseen circumstances.

Contact Flexible Accounting Services of the Triangle today if you are considering the sale of your home. We can assist you in minimizing the tax on the sale through proactive tax planning.