The Taxpayer Relief Act of 1997 made important changes when you sell your primary residence. Previously you could roll unlimited gains into a new home, but could only take a one-time exclusion of $125,000. The 1997 law lets you exclude up to $250,000 of gain ($500,000 for joint filers) every two years, with no need to roll your gains into a new home.
You can exclude up to $250,000 of the gain when selling your home if:
- You own it for two of the last five years,
- You occupy it as your primary residence for two of the last five years, and
- You haven’t used the exclusion within the last two years.
You and your spouse can exclude up to $500,000 if:
- Either of you own it for two of the last five years
- Both of you use it as your primary residence for two of the last five years, and
- Neither of you has used the exclusion within the last two years.
You can exclude a partial share of your gain (calculated by dividing the number of months you qualify by 24) without meeting the two-year minimum, if your move is due to:
- Change in employment (you, your spouse, a co-owner of the house, or any other person whose principal abode is in the home accepts a job whose location is at least 50 miles farther from the home than their previous place of employment);
- Health (a qualifying person or their relative moves to treat a disease, illness, or injury or to obtain or provide medical care for a qualified individual); or
- “Unforeseen circumstances” (including, but not limited to, involuntary conversion, natural or man-made disaster, or a qualifying individual’s death, unemployment, change in employment or self-employment status, divorce, or multiple births from the same pregnancy).
For example, a taxpayer who owns and uses a principal residence for one year and then moves because of a job transfer may exclude up to $125,000 (half of the regular $250,000 exclusion). Assuming the homeowner realizes only a $75,000 gain, it is all excluded, rather than only half of the $75,000.
If your gain is more than your tax-free exclusion, report the excess as short-term or long-term gain on Schedule D. If you’ve taken any depreciation on the property, you’ll have to treat it as “unrecaptured Section 1250 gain.” This essentially means reporting it as income and paying tax on it, but capped at 25%.
You may be able to use the exclusion to save tax when you sell vacation or rental property. You do so by moving into the property yourself and occupying it as your primary residence, for the necessary two-year period. You’ll have to treat any depreciation you’ve taken as “unrecaptured Section 1250 gain” when you convert rental property to residential use. But, no further tax is due unless your final gain exceeds your $250,000 or $500,000 exclusion.
The 2008 Housing Act eliminates the exclusion for periods beginning in 2009 where you do not use the property as your principal residence. There’s no need to appraise the property to determine interim value; the new law determines excluded appreciation on a pro-rata basis, according to how long you own it.
If your spouse dies while you own your home jointly, their basis is “stepped up” to half of the home’s fair market value on the date of their death (100% in community property states). You can exclude up to $500,000 in remaining gain if you file jointly in the year in which your spouse dies.
If you have any questions regarding the best tax break for homeowners, please do not hesitate to contact us.