Introductory Note
Tax laws change so the information found in this post may become stale over time. Future readers are encouraged to consult Internal Revenue Service (IRS) Publication 530: Tax Information for Homeowners for recent updates.
Principal Residence Exclusion
Home prices are soaring right now. The market values of some homes purchased just a few years ago have appreciated significantly. If you are looking to sell your home, it is important to know the potential tax ramifications. Avoiding capital gains tax on tens of thousands or even hundreds of thousands of dollars is a big (financial) deal.
The IRS excludes up to $250,000 in gains for individuals or up to $500,000 in gains for married couples filing jointly from the sale of a primary residence if certain conditions are met. To be clear, the exclusion does not apply for second homes or vacation homes, only primary residences. Let us examine these conditions that determine eligibility.
Determining Eligibility
There are a two (less common) obstacles that would immediately disqualify you from the principal residence exclusion: (1) your property was acquired through a like-kind exchange or (2) you are subject to expatriate tax. Assuming you are not immediately disqualified, you can proceed to the following 3 core tests to determine if you are eligible for the exclusion.
Ownership Requirement - You must have owned the home for at least 24 months (2 years) out of the last 5 years leading up to the date of sale. For a married couple filing jointly, only one spouse has to meet the ownership requirement.
Residence Requirement - You must have lived in the home as your primary residence for at least 24 months out of the last 5 years. The 24 months (730 days) can fall anywhere within the 5 year period and does not have to be a single block of time. For example, if a warm weather loving married couple lived in their Florida home for only the fall and winter of the last 5 years, then they would meet the requirement (6 months x 5 years = 30 months). For married couples (filing jointly), each spouse must meet this requirement individually.
Look-back Requirement - You may take the exclusion only once during a 2-year period. If you sold another home in the last 2 years and used the exclusion, then you are not eligible.
As you can see from these guidelines, the bottom line is that many Americans who have lived in their home for at least the last 2 years will qualify for the exclusion. However, there are some exceptions for unique circumstances. The primary situations that require more detailed analysis to determine eligibility are those where individuals are (1) divorced, (2) widowed, (3) spent time elsewhere for medical care (e.g., nursing home), (4) own multiple homes, (5) military service personnel, (6) expatriates, or (7) involved in a health or work-related move or some other unforeseeable event. If need be, individuals in these categories should seek professional assistance to make certain that they are not missing out on this valuable exclusion if an exception applies.
Joshua Hall, ChFC