Selling a home can be a major event in the lives of its owner. However, thanks to recent changes in the IRS code, selling a home does not have to be a major tax event. In fact, for a majority of Americans, selling a home has no affect on their federal income taxes.
According to rules enacted in 1997, a person can exclude up to $250,000 in capital gains from the sell of a home. For a married couple that files jointly, up to $500,000 in capital gains can be excluded for federal tax purposes.
However, in order to take the exclusion, the home being sold must be your principal residence. In addition, you must have lived in the home for two of the last five years, and have owned the home for at least five years. For a married couple, only one of the partners has to meet the ownership rule, but both must meet the lived-in rule. Otherwise, only the single $250,000 exclusion is allowed.
It is important to understand that these exclusions can only be taken on the sale of your principal residence every two years. If you sell your principal residence more than once in a two-year period, then the transaction will become a taxable event. However, as is so often the case when dealing with taxes, there is an exception to this rule. If the sell of the second home within the two year period is due to change in employment, health reasons, or unforeseen circumstances as defined by the IRS, then a smaller exclusion is allowed.
For those people who do not meet the exclusion requirement, then it is vital to understand exactly how to report the gain on your federal income tax. The gain from the sale of the home is the selling price of the home minus the expenses from the sale of the home. Then take the basis of the home which is the price that you originally paid for the home and subtract the selling price. This final figure is the realized gain from the sale of the home. This is the figure that must be reported on your federal income taxes.
It is also important to note that a loss from a sale of a home cannot be deducted on your federal income taxes. So, if you actually lost money in the transaction, that is your loss to eat the federal government will not help you in that regard.
One other area where the IRS limits the exclusion from the sell of a home involves a home that is both a residence and a place of business. In such circumstances, the area of the home that is used for living and the area that is used for business must be separated. The area that is used for living is then subject to the exclusion rules of the IRS.
The gain on the area that is used for business purposes, such as a farm or a storage area where you lived in an upstairs apartment is fully taxable. The exception to this rule is a residence where a room was used for a home office. In this situation, it is not necessary to divide the home and figure the separate gains.
The bottom line on all of the IRS rules regarding gains from the sell of a home is that most people will not be affected. Most single individuals will not post a gain above $250,000 on the sell of a home. In addition, most people are not going to sell a primary residence more than once in a two-year period.
However, if you are required to report gains from the sell of a home, it is important to consult an experienced tax professional to insure that all gains and exemptions are reported correctly.