Tax Breaks

Tax Planning for Selling Your Home

Simple guidelines for selling a home tax-free

March 2012

If you are selling your primary home, the tax law allows you a very generous exclusion for the profit you have made. In fact, most home sales escape taxation altogether. So when you sell your home, you'll probably find packing up and unpacking in your new home to be a much harder task than calculating your income-tax bill from the sale. There's a good chance, in fact, that you won't even have to report the transaction to the IRS.

How do I calculate my profit? From the net sales proceeds (that is the selling price minus the selling expenses, including the real estate agent's commission), subtract the adjusted tax basis in the home. Your adjusted basis is basically the original cost of the home plus the cost of capital improvements you've made, such as a new roof, a remodeled kitchen, a swimming pool or central air conditioning. If you sold a home before mid-1997 and rolled over profit from that sale into the home you just sold, your basis is reduced by the amount of that untaxed profit.

How much gain can I exclude? You can treat as tax free up to $500,000 of the profit from the sale if you're married filing jointly or up to $250,000 if you're single. (If you sold for a loss, you cannot deduct the loss.) You can use this exclusion every time you sell your primary home, as long as you own and live in the home for two years and haven't sold another home in the last two years. If the home-sale exclusion doesn't cover all your profit, the excess gain is reported on Schedule D with your other capital gains and losses.

How do I qualify to claim the home-sale exclusion? There are three tests you must meet in order to exclude the gain from the sale of your main home:

*Ownership: You must have owned the home you are selling for at least two years (730 days or 24 full months) during the five years prior to the date of your sale.
*Use: You must have used the home as your principal residence for at least two of the five years prior to the date of sale.
*Timing: You have not excluded the gain on the sale of another home within two years prior to this sale.

Also, if you are married,
*You must file a joint return.
*You or your spouse, but not necessarily both of you, must have owned the house for the requisite time.
*You and your spouse must have lived in the house for the requisite time.

What if I don't fully satisfy all the tests for the exclusion? If you don't meet the ownership or use tests, your gain generally is taxed as short-term or long-term capital gain, depending on whether you owned the home for less or more than one year, respectively. But there's a special rule that allows you to use a portion of the $250,000 or $500,000 exclusion if you needed to sell your home because of a change of employment, a change of health or other unforeseen circumstances, such as:

*Divorce
*Multiple births from the same pregnancy
*Broken engagement of a couple who jointly bought a home.

For example, assume you are single and sold your primary home one year after you bought it due to a job change. Say your profit was $30,000. Because you lived there for half the requisite period, you are entitled to claim half of the $250,000 exclusion, or $125,000. Thus, none of your $30,000 profit is taxed.

Do I have to report the home sale on my return? You generally do not need to report your home sale on your income tax return, as long as you did not receive a Form 1099-S, Proceeds from Real Estate Transactions, from the real estate closing agent (that is, a title company, real estate broker or mortgage company). To avoid getting this form, you must certify that you meet the ownership, use and timing tests we noted earlier.

First-time homebuyer credit. If you received the $7,500 first-time homebuyer credit for the purchase of a home in 2008, you must repay the credit by adding $500 each year to your tax bill – for 15 years – starting with your 2010 return. And, if you sell the home before the end of that 15 year period, you must repay any part of the credit that remands unpaid with the tax return for the year of the sale.

In general, the $8,000 credit for first-time buyers and $6,500 credit for long-time residents who bought homes in 2009 and 2010 does not have to be repaid -- unless you sell the home or otherwise stop using it as your principal residence within three years of the time you bought it. If you move out of the place before those 36 months are up, you have to repay the credit with the tax return for the year you leave the house. Note: You never have to repay more than the profit on the sale of the home. So, if you sell for a loss during the three year period, you don't have to repay the credit.

There are a few exceptions to the repayment requirement. It's waived in the case of death, for example, or if the home is "involuntarily converted" from your principal residence (i.e. destroyed in a storm) and you buy a new principal residence within two years.

Another exception waives the repayment requirement if the owner transfers the home to a spouse or former spouse incident to a divorce. And, service members who cease using the home as a principal residence within three years as a result of being deployed more than 50 miles away from the home for more than 90 days or indefinitely do not have to repay the credit.

If none of the exceptions apply, however, someone who sells for a profit or ceases to use the home as his or her principal residence during the first 36 months after purchase would be required to repay the credit.

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