Home Sale Gain Exclusion Rules

Q: Tax Playa, can I sell my home and not have to pay capital gains tax?
Megan, Arlington VA

A: In general, taxpayers can exclude up to $250,000 of gain on the sale of a principal residence that they have lived in and owned for 24 of the 60 months immediately-prior to sale (in the case of co-owners of a home, the exclusion is $500,000).

However, as with anything else, there are lots of exceptions and caveats.

For more in-depth information on this topic, you should reference IRS Publication 523, "Selling Your Home."

The first task is to determine what your gain is on the sale (if any).  Gain is calculated by the following formula:

Sales price - net closing costs of sale - purchase price - net closing costs of purchase + depreciation

What's left is your gain or loss.  If you have a loss from the sale of a residence, this is considered a personal loss, and is not deductible (even against other capital gains).

Most people have a gain when they sell their home.  This gain cannot be "rolled over" into your next home (that is an urban myth that has survived despite the law change of nearly ten years now).

As with any capital gain, it can be short-term (<1 year of ownership), or long-term (>1 year of ownership).  Short-term capital gains are taxed as ordinary income.  No exceptions.

Long-term capital gains are taxed at favorable rates.  The federal capital gains rate on long-term sales is 15%.

The exclusion mentioned above can be invoked if you lived in your home and owned your home for any 24 months out of the 60 months prior to sale.  You can move in and out, but in total, the months must equal 24/60.  Any gain that exceeds the excludable amount is taxed at the 15% capital gains rate.

The exclusion amount can still be partially claimed if there is a qualified exception.  These include:

1. A change in place of employment (usually should be more than 50 miles and proximal to the time you start the new job);
2. Health reasons (can be for yourself or a family member, probably with a medical recommendation from a doctor)
3. "Unforeseen circumstances" (includes but is not limited to eminent domain, casualty loss, death, unemployment, loss of ability to earn enough income, divorce or legal separation, birth of twins or higher)

If you qualify for the partial long-term capital gain exclusion, you take a pro-rated amount.  For instance, suppose you qualify for the change in employment exception and lived in/owned your home for 18 of the 60 months prior to sale.  You are single.  18/24 is 75%.  75% of $250,000 is $187,500.  Therefore, your exclusion amount is $187,500.  Any gain above this is taxed at the long-term capital gain rate of 15%.

If you rented out your home or claimed a home office deduction (or did any other depreciation), the "recapture" of that depreciation is treated differently depending on when you claimed the depreciation:

1. Depreciation claimed prior to 5/6/97.  The exclusion amount can cover this recaptured depreciation as well as regular long-term capital gains (but only after all long-term capital gains have been excluded).
2. Depreciation claimed subsequent to 5/6/97.  The exclusion amount cannot cover any depreciation deduction recapture for deductions after this date.  The exclusion can only cover the regular long-term capital gain.  The recaptured depreciation must be done separately, but at the (usually favorable) rate of 25%.

The bottom line is that most people who have lived in their homes for awhile can usually exclude the entire sale.  The above rules are a good way to make sure that there are no taxes owed.

Comments

[M Benjamin]

I've never heard of adding "depreciation" when you are calculating the gain on the sale of a home.

But I thought that one does add to the cost basis of the home the cost of any improvements made to the home.