The tax rules allow certain gains on the sale of homes to be excluded from taxable income.
Home ownership has always been part of the American dream. That dream took a “hit” during the Great Recession when many homes were underwater (the market value of the home was less than the outstanding mortgage) and foreclosures soared. This phenomenon and a variety of other factors led to an increase in renters, in lieu of home ownership, by approximately 5 percent (36% to 41%) between 2006 and 2014. This occurred for a variety of reasons and across many demographics.
Home ownership has always been a significant part of the net worth of Americans.
Gains on Sale of Homes – Old Rules
In order to promote home ownership and to protect the increase in net worth of American homeowners, taxpayers could either defer income tax on gains on the sale of homes, or exclude the gain from taxable income, but only “once in a lifetime”. The tax law, prior to 1997, allowed homeowners to defer paying tax on gains on the sale of a principal residence if the sales proceeds were reinvested in a new home of equal or greater value within two years of the sale. Taxpayers who were 55 and older were also allowed to exclude up to $125,000 of the gain – “once in a lifetime”.
Gains on Sale of Homes- Current Rules
Recognizing the increasing value of homes and the mobility of American families, the tax law was amended in 1997. They new tax law is available to Americans of all ages who meet certain qualifications. There are many intricacies of the new rules and many fact specific situations. However, generally speaking:
- Gains on the sale of homes of up to $250,000 for singles and $500,000 for jointly filed returns, is not taxable.
- The property must be your principal residence, as defined.
- You must own the home and live in the house for at least two of the five years prior to the sale. Ownership and living in the home do not have to happen at the same time.
- There is no limit on the number of times you can sell your home and have a tax free gain. You could use this method of excluding the gain from taxable income every two years.
Calculating Gains on Sale of Homes
Gains on the sale of homes can be non-taxable to all age groups. To figure out your gain you must determine the basis in your home. Your basis is what you paid for your home and all capital improvements like adding a room or finishing a basement. You compare that basis amount to what you get from the sale, less your commissions and other expenses. The difference is your gain or loss. It is important to keep good records for the detail of your gain calculation.
This IRS publication provides additional guidance on: whether or not your home sale qualifies for the exclusion, figuring out your gain or loss, how homes used for business or rentals are effected and other fact specific situations. However, if you have specific questions or comments include them with the comments below and we will respond.