If you sell your principal residence for a profit, how is that profit taxed? A lot of folks think the gain is subject to tax, no matter what. Some think as long as you reinvest the sale proceeds the gain is “deferred”. Some even think you can only “defer” the gain once. With the prices of homes rising significantly in many places, I thought it would be good to clear up some of the misconceptions.
The old “reinvest” rule was removed many years ago and replaced with a much more taxpayer friendly rule. As long as you pass the appropriate tests, you can exclude up to $250,000 of gain if you’re unmarried, and up to $500,000 if you’re married.
To use this exclusion, you must first pass the Ownership Test, which says that you must have owned the home for at least two years out of the five-year period ending on the sale date. Second, you must pass the Use Test, which says that you must have used the home as your principal residence for at least two years out of the five-year period ending on the sale date.
Determining if the home is your principal residence is pretty straightforward if you own only one home, but if you own more than one home, it can be a little less clear. The general rule is where you spend the majority of your time, but other factors to consider include where you work, where your family members live, the address you put on your tax return and driver’s license, and where you’re registered to vote.
Obviously, if you sell your principal residence for a profit, and you meet the tests, you will want to exclude the gain. But if you noticed, I said each test had a “two out of five” test, so theoretically, if you own two homes, and you split your time pretty evenly between the two homes, you could make a case that, in a five-year period, you would have lived in each home, as your principal residence, for 2½ of the five years. There are other situations where you could have two qualifying homes at once, but there is a prohibition against using this rule more than once in a two-year period. If you sell your primary residence and exclude the gain on March 15, 2022, you could not exclude the gain on another primary residence until March 16, 2024.
There are lots of other “special circumstances” that may affect you. What if you have two homes that you intend to sell within a short time, and both will be sold at a profit? If you report one sale and pay the tax on that profit, you can still exclude the other gain.
What if you intend to sell two homes, and one has a profit, but the other will be sold for a loss? You can exclude the gain, but the loss is not tax-deductible.
In order to exclude the full gain on the sale of your home, you have to meet the Ownership and Use Tests, but what if circumstances cause you to have to sell your home and you don’t meet the full two-year test? There are circumstances where you can still exclude a portion, or possibly all of your gain. To take advantage of this rule, your sale must be because of a change in the place of employment, health reasons, or some other specified unforeseen circumstances.
There are a lot of specific situations where you can prorate the exclusion amount. And if you qualify, the proration is of the maximum, not your gain. So for example, if you have a $50,000 gain and you’re selling your home of only 12 months, and you qualify for the proration, you would be able to exclude the full gain because your exclusion would be half of the maximum, or $125,000 if you’re unmarried, and $250,000 if you’re married
There are lots of other special situations. As I said, this is a taxpayer friendly rule, so if you’re selling your home at a profit, be sure you check all the rules before you pay tax on the gain. There may be an exclusion available. If you would like help with determining if you will owe tax on your home sale, please email our office at firstname.lastname@example.org and we’ll help you find the answer. I am looking for article ideas so if you have a topic that you would like me to cover, please send me an email.