If you are selling your home, there is a good chance that the profit or a portion of the profit from the sale will not be taxable. Thanks to the Section 121 Exclusion (commonly referred to as the home sale exclusion), provided by the Internal Revenue Code, individual taxpayers can exclude up to $250,000 in profits from capital gains tax when they sell their primary personal residences, while married taxpayers can exclude up to $500,000 in gains.
Calculating Your Capital Gain or Loss
To calculate your capital gain or loss on the sale of your residence you subtract your cost basis from your sales price. The cost basis starts with what you paid for the home plus the costs you incurred in the purchase, such as title fees, escrow fees, and real estate agent commissions. Then add the costs associated with any major improvements you made, such as replacing the roof or the furnace, you made to the home. Minor renovations or maintenance costs such as painting a room do not count. Then subtract any accumulated depreciation you may have taken over the years, if any, based on items like taking a home office deduction. The resulting number is your cost basis.
Your capital gain or loss is the sales price of your home minus your cost basis and any expenses related to the sale (commissions, fees, etc.). If you end up with a capital loss, you cannot claim a deduction for the loss under the Internal Revenue Code.
If you end up with a capital gain, you can subtract the home sales exclusion, if eligible, to determine your taxable gain. To be eligible for the exclusion, you must have lived in the home for a minimum of two of the five years immediately preceding the date of sale. The two years do not have to be consecutive, and you do not have to live there on the date of the sale.
Know the Details
You can use this two-out-of-five-years rule to exclude your profits each time you sell your main home. However, you can claim the exclusion only once every two years because you must spend at least that much time in the residence. You cannot have excluded the gain on another home in the last two-year period.
You also want to document any unforeseen circumstances that might force you to sell your home before you’ve lived there the required period of time. The IRS defines an unforeseen circumstance as an event that you could not reasonably have anticipated before buying and occupying your main home. Natural disasters, a change in employment that left you unable to meet basic living expenses, death, divorce and multiple births from the same pregnancy qualify as unforeseen circumstances under IRS rules. Any unforeseen circumstances may result in you getting a partial exclusion.
Active-duty service members are not subject to the residency rule. They can waive the rule for up to 10 years if they’re on qualified official extended duty.
If you realize a profit in excess of the home sale exclusion or if you do not qualify for the exclusion, you will report the sale of your home on Schedule D of your Individual Tax Return.
Be advised this is just a summary and there may be other provisions and exceptions applicable to you. Be sure to consult a tax professional before filing.
If you need assistance or have any questions on the information in this article, please call your CironeFriedberg professional. You can reach us by phone at (203) 798-2721 (Bethel), (203) 366-5876 (Shelton), or (203) 359-1100 (Stamford) or email us at info@cironefriedberg.com.
