With near-record-low home mortgage interest rates, the housing market has been booming. September 2020 existing home sales were up 9.4% from August 2020 and 20.9% from 2019, according to the National Association of Realtors. If you sold your home this year or are thinking about selling it, there are many tax-related issues that could apply to that sale. To help you prepare for reporting the sale you may have already made or make you aware of what issues you may face if you are in the “thinking about” stage, this article covers the tax basics and some special situations related to home sales and the home-sale gain exclusion.
Home Sale Exclusion
For decades, Congress has encouraged home ownership, including by providing a tax break for taxpayers selling their homes. Under the current version of the tax code, you are allowed an exclusion of up to $250,000 ($500,000 for married couples) of gain from the sale of your primary residence if you owned and lived in it for at least 2 of the 5 years previous to the sale. You also cannot have previously taken a home-sale exclusion within the 2 years immediately preceding the sale. There is no limit on the number of times you can use the exclusion as long as you meet these time requirements; however, extenuating circumstances can reduce the amount of the exclusion. The home-sale gain exclusion only applies to your main home, not to a second home or a rental property.
2 out of 5 Rule
As noted above, you must have used and owned the home for 2 out of the 5 years immediately preceding the sale. The years don’t have to be consecutive or the closest to the sale date. Vacations, short absences and short rental periods do not reduce the use period. If you are married, to qualify for the $500,000 exclusion, both you and your spouse must have used the home for 2 out of the 5 years prior to the sale, but only one of you needs to meet the ownership requirement. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000.
Although this situation is quite rare, if you acquired the home as part of a tax-deferred exchange (sometimes referred to as a 1031 exchange), then you must have owned the home for a minimum of 5 years before the home-gain exclusion can apply.
If you don’t meet the ownership and use requirements, there are some situations in which a prorated exclusion amount may be possible. An example of this situation would be if you were required to sell the home because of extenuating circumstances, such as a job-related move, a health crisis or other unforeseen events. Another rule extends the 5-year period to account for the deployment of military members and certain other government employees.
Other Considerations
Special rules apply on the sale of your home if it was previously used as a rental or as a home office. You may have gain to the extent of the depreciation claimed and you may have suspended losses available. Tax laws are complex and you could owe taxes unexpectedly without proper proactive planning.
