The tax code authorizes “exclusions” that allow home sellers to completely sidestep federal and state income taxes on sizable portions of their profits when they unload their principal residences. The profit exclusions are as much as $500,000 for married couples who file joint returns and $250,000 for single filers and couples who file separate returns. So says Julian Block, an attorney and former IRS special agent.
Contrary to what many sellers mistakenly believe, the exclusions aren’t one-time opportunities. They can avail themselves of the exclusions as often as every two years.
The law allows a seller we’ll call “Louise” to qualify for the exclusion only if she satisfies two requirements:
- She has owned and lived in the property as her principal residence or main home for at least two years out of the five-year period that ends on the date of sale.
- She can’t have excluded the gain on the sale of another principal residence within the two years that precede the sale date.
An accommodating Internal Revenue Service cuts Louise some slack on the two years that she occupies the home. The two years don’t have to be consecutive; they can actually be off and on for a total of two full years.
What about short temporary absences for vacations or other seasonal absences? No problem, says the IRS. It’s OK for Louise to count them as periods of owner use. This holds true even if she rents out the property during the absences.
The IRS doesn’t limit exclusions to sales of conventional single-family homes. It considers Louise’s principal residence to be any of the following:
- A condominium.
- A cooperative apartment.
- Her portion of a multi-unit apartment building.
- A house trailer.
- A mobile home.
- A houseboat or yacht that has facilities for cooking, sleeping and sanitation.
- A vacation retreat that she moves into full time after retirement.
Another plus: The location of her principal residence doesn’t matter. It can be outside the U.S.
Partial profit exclusions. Suppose Louise sells another home within the previous two years or fails to satisfy the ownership and use requirements; all is not lost. She may be able to claim a partial exclusion.
Primary reasons for sales. The IRS permits sellers to avail themselves of reduced exclusions only when the primary reasons are health problems (for example, if Louise moves to a new school district for her special-needs child); changes in employment; or certain unforeseen circumstances, broadly defined to include divorces or legal separations, or natural or man-made disasters that cause residential damage — floods, for example.
An example: Louise is single and has lived in her dwelling for just 12 months before she moves to a new job in another city. She can exclude a gain of as much as $125,000 — 12 months divided by 24 months, or 50% of her maximum allowable $250,000 exclusion.
The bottom line? Don’t make assumptions about what you may or may not be allowed to deduct. Work with a tax professional to make sure you get everything you’re entitled to claim.
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 firstname.lastname@example.org.