Selling Your Home? Sale of Home Capital Gains & Other Tax Factors

September 6, 2011 | By: Charles P. Corsello, EA

tax considerations of home saleThere are several factors to consider when selling your home, especially in an economy where every cent counts. It is essential for homeowners to understand how actions related to selling a home will impact their finances and, in particular, their tax liabilities.

Since purchasing or selling a home may be the most significant financial transaction that the average consumer will make in his lifetime, knowing precisely how these transactions will affect your taxes is crucial. Here we look at how the sale of your home may affect your tax situation, as well as some ways for you to reduce any tax liability.

Capital Gains

The main area of focus when determining how the sale of your home will impact your taxes is capital gains. A capital gain is defined as an increase in the value of an asset – such as an investment or real estate – that makes that asset worth more than the original purchase price. Capital gains are not realized until the sale of the asset is complete; therefore, when selling your home, you may find yourself with a capital gain that must be reported on your income tax return. If capital gains cannot be offset by capital losses, the amount is taxable. Fortunately, there are several ways to avoid paying taxes on capital gains that result from your home sale if you know the exceptions and exclusions accepted by the IRS.

Exceptions and Exclusions

The IRS allows homeowners to exclude up to $250,000 ($500,000 for married couples) of the gain that results from the sale of their primary residence if all of the following statements are true.

  • Meet ownership test: The home was owned for at least a 24 month period.
  • Meet the use test: If the home in question was used as your primary place of residence for at least two out of the five years before the sale of the property.

If for some reason you have capital gains that cannot be excluded (your gain exceeds the amount allowed), and you have not met the use test, you may still qualify for a partial exclusion. The reasons accepted for a partial exclusion include a significant life event (unforeseen circumstance: death, divorce, multiple births), change in employment or a recommendation from your doctor to move for health reasons.

When You Cannot Claim an Exclusion

Several factors affect whether or not you can claim exclusions on your tax return to avoid paying taxes on capital gains. If, for example, you already claimed an exclusion for the sale of a home during the same period, you would not be allowed to do so again.

First-Time Homebuyer Credit Considerations

Another factor affecting homeowners is receipt of the first-time homebuyer credit. If this credit was received and the property is no longer used as the primary source of residence within the first 36 months of the purchase date, the credit must be repaid.

How to Handle Exclusion on Tax Return

When filing your tax return, use worksheets included in Publication 523, Selling Your Home to determine capital loss or gain on the sale of your home. This will help you calculate exactly how much you may exclude on your taxes. You must also update your address with the IRS and United States Postal Service. Form 8822 can be used to notify the IRS of a change in address, which will ensure that you receive any IRS correspondence regarding taxes, refunds, etc. promptly.