When interest rates were lower, we saw a lot of people selling their homes. So much so that the housing market became overheated in some parts of the country. For many people, any gain on the sale of their home will probably not be taxable, but there are still cases where it will.
Let’s start with the basics.
- The current rules state that a taxpayer can exclude up to $250,000 if single or $500,000 of gain if married.
- To qualify for the exemption, the taxpayer must meet two requirements-
- The ownership test which says that you must have owned the home for two of the last five years.
- The use test which says that you must use the home as your main home for the same two of the last five years.
- Either test does not need to be consecutive. So as long as you owned and occupied the home for 366 days over the five-year period, you should be ok.
I remember in the past that you needed to buy another property to get the exemption, is this still true?
- These rules are no longer applicable, but we do still have a lot of clients asking this question.
How do I calculate the gain to see if I am under the exclusion amount?
- The basis would be calculated similar to how you would calculate it for any other asset.
- You would take the amount that you paid for the property and add any major improvements such as windows, siding, additions or other improvements.
- You would not count normal repairs and maintenance, real estate taxes, utilities, etc. So the expenditure would have to be for something that improved the property.
I know people who transferred their house to their kids, how does basis work for that?
- I am glad you brought that up.
- I certainly understand transferring property so it is not counted later for nursing home purposes, but if you do this there are things that you need to be aware of.
- Let’s say that mom and dad transfered a house to the kids and it is later sold, there may be a taxable gain on that sale since the new owner may not qualify for the exclusion.
- The basis is whatever mom and dad paid for the property plus their improvements, it is NOT the value at the date of the gift. This can lead to some unexpected tax consequences.
Does the sale need to be reported on a tax return?
- It depends.
- If you receive a Form 1099-S which shows how much you sold the home for, then you will need to report that on your return.
- If you do not report it, the IRS will send you a matching notice as they have income that reported to them but not included on your return.
- This makes sense, since the IRS knows the gross proceeds, but they do not know what your basis is unless you tell them.
- I normally recommend reporting it on your return, just to avoid a potential notice.
Are there any exceptions to the two-year rules?
- There are some exceptions for separation or divorce.
- There is another exception for the death of a spouse.
- There are other exceptions for homes that were destroyed or condemned or if you were a service member.
- There are also partial exemptions for work related moves, health related moves and other unforeseen events.
Be sure to talk to one of our professionals if you have any questions regarding the sale of a home.
As a partner, I have thorough experience providing tax services to individuals, privately held businesses, nonprofit entities and estates and trusts. I also provide compilation and review services.
