The residential housing market has been on a tear and if you sold your home this year, your tax planning should begin right away.
A lesser-known part of the tax code allows homeowners to exclude some gains on the appreciation of their home as long as they meet two requirements. The home sale exclusion allows single individuals to exclude up to $250,000 of a gain and up to $500,000 for married couples who file taxes jointly. The exclusion is still in the Tax code and is a substantial tax-saving opportunity for anyone who owns a home, condo, mobile home or co-op.
For example, if a married couple purchased a home 10 years ago for $500,000 and they later sell their home for $1,000,000, they are considered to have a $500,000 gain or increase in value above what they paid. Without the home exclusion available in the tax code, this couple would have to pay taxes on that $500,000 gain. Because of the home exclusion, they would not have to pay any taxes on gains from the sale in this simplified example. If their home sold for $1,100,000 they would still receive the $500,000 gain exclusion but would have to pay personal income taxes on the $100,000 in gain remaining. You, as the seller, need not complete any special tax form to take advantage of this tax break.
To be eligible for the principal residence gain exclusion, you must pass two tests: 1) the ownership test, and 2) the use test.
The two-year period does not have to be in consecutive years or months. For example, a married couple who lived in the home the first year they bought it, then moved elsewhere, but moved back and lived in the home for another year and a half, could still use the home exclusion as long as they lived in the home for two out of the past five years. The IRS will look at the number of months the home was your primary residence out of the five years.
For married couples, in order to receive the full $500,000 tax exclusion the couple must be married and file a joint tax return. Either spouse can qualify for the ownership test, but both spouses must meet the two year use test using the home as their primary residence. For unmarried joint owners, each owner would be able to claim the individual $250,000 tax exclusion as long as they also meet the use test.
An important allowance applies to recent widows. The current law allows for widows to be able to access the full married exclusion amount of $500,000 if they sell the residence within two years of their spouses’ date of death. The same ownership and use tests would apply, but the government will allow the surviving spouse to exclude the larger $500,000 gain as if their spouse was alive in an attempt to assist the widow. For widows whose spouse recently passed away, this is an important planning consideration if they are discussing downsizing or moving to a different residence.
Another significant part of the law states the exclusion is generally available only when you have not excluded an earlier gain within the two years ending on the date of the later sale. In other words, naturally, you cannot recycle the gain exclusion privilege until two years have passed since you last used it.
If you have recently sold your primary residence, or intend to soon, it is always recommended to speak to your licensed tax advisor.