Capital Gains on Your Home Sale

When you sell your primary residence, you can make up to $250,000 in profit if you're a single owner, or up to $500,000 if you're married, and not owe any capital gains taxes.
Some sellers are surprised by this break, especially if they've been in their homes for a while. That's because before May 7, 1997, the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years. Sellers age 55 or older had one other option. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. And in all instances, there was Form 2119 to fill out to show that you followed the rules.

But when the Taxpayer Relief Act of 1997 became law, the home-sale tax burden eased for millions of residential taxpayers. The rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts.

If you used pre-1997 rules for residential sales, don't worry. That doesn't disqualify you from claiming the exclusion on any residential sales now. The law change applies to all sales since it took effect.

Another bonus to the new rules? You don't have to buy another home with your sale proceeds. You can use the money however you wish.

Even better, there's no limit on the number of times you can use the home-sale exemption. In most cases, you can make tax-free profits of $250,000, or $500,000 depending on your filing status, every time you sell a home.

There are some exclusions and rules that a homeowner must follow:

First, the property you're selling must be your primary residence. That means you live in it. This tax break doesn't apply to a house or other property that you have solely for investment purposes. In those cases, the usual capital gains rules apply.  You also must live in that principal residence for two of the five years before you sell it. This is known as the use test. It also means, practically speaking, each sale must be at least two years apart.  That still leaves you room to make some money on several properties. You can sell your residence this year, pocket any gain within the tax limits and buy a new residence. Two years later, you can do the same thing, again and again, every two years. 

Second home sales take a tax hit

Owners of multiple homes, however, will now find it's not as easy to shelter sale profit as it used to be. A provision of the Housing Assistance Act of 2008, the bill designed primarily to provide relief to some homeowners facing foreclosure, could cost the owners of a vacation or other type of second property -- when they sell.

Previously, you could move into the second property, make it your primary residence, live there for two years and then sell it and pocket most or all of the profit. Now, however, even if you convert a second piece of real estate to your primary home, you'll owe tax on part of the sale money based on how long the house was used as a second, rather than your main, residence.

Special rules for married couples

While a husband and wife get double the exclusion of single home sellers, couples also have some additional considerations when it comes to determining whether their sale is tax-free. Either spouse can meet the ownership test. For example, the IRS says it's OK if you owned the home for the past two years, but you just added your new husband to the title when you got married six months ago. Since you owned the residence for the required time, as joint filers, you have no problem meeting the ownership test even though your husband wasn't an official owner for that long.  However,  both husband and wife must pass the use test; that is, each must live in the residence for two years. But the shared use doesn't have to be while you file jointly. If you and your now-husband shared the home for 1 1/2 years before you were legally married and then six months as husband and wife, the IRS will allow you to claim the exemption. 

Under this couple requirement, if either spouse sold a home and used the exclusion within two years of the sale of any jointly owned property, the couple can't claim the exclusion. That means if your new husband sold his town house a month before the wedding, then you'll have to wait two years after that property's sale date before you can dispose of your shared marital residence totally tax-free. In some cases, a couple might be able to exclude some profit from taxation, but not the full $500,000 allowed joint filers, based on one spouse's eligibility qualifications.

As a property seller, you naturally focus on how much you got for your house. That is an important number, but not the only one you'll need when it comes to figuring out whether you'll owe taxes on the sale and have capital gains.

It's your gain, or profit, that determines the size or lack of a tax bill. In fact, you can sell your house for $1 million and still not owe capital gains as long as the profit portion was not more than $250,000 or $500,000, depending on your tax filing status. If you can exclude all the gain, then you owe no taxes.

To arrive at your gain amount, you first must establish your basis in the home.  Also, if you sold a residence prior to the 1997 law change and rolled the profit into the home you're now selling, you must account for that rollover amount; your basis will decrease by the amount of gain you postponed years ago.

Special rules for special circumstances

Members of the military also get special home-sale consideration. Because of redeployments, soldiers often find it hard to meet the residency rule and end up owing taxes when they sell.

But a law change in 2003 exempts military personnel from the two-year use requirement, for up to 10 years, letting them qualify for the full exclusion whenever they must move to fulfill service commitments.

Another law change, this one beginning in 2008, takes into account the special circumstances that a homeowner faces when selling after a spouse dies.

Previously, to exclude the full profit amount allowed married homeowners when they sell, the surviving spouse had to sell the property in the same tax year that the husband or wife passed away. But now, an unmarried widow or widower has up to two years to sell the home and not face taxes on up to $500,000 in profit.

For more information on Capital Gains, contact your CPA or tax preparer or the IRS at :