Selling your primary residence involves specific tax rules that can significantly impact your financial outcome. The IRS views the profit from selling your home as a capital gain if the selling price exceeds your adjusted basis—the original purchase price plus qualifying improvements such as renovations. Fortunately, the Taxpayer Relief Act of 1997 introduced the Section 121 exclusion, allowing homeowners to exclude up to $250,000 of capital gains if single or $500,000 if married filing jointly, provided they meet ownership and use tests.
To qualify, you must have owned and lived in the home as your main residence for at least two of the five years immediately preceding the sale. This period doesn’t need to be continuous. Additionally, you can claim this exclusion only once every two years. If you meet these criteria, you may avoid paying capital gains tax altogether on the profit from your home sale.
Your primary residence is the home you occupy most of the time, including houses, condos, co-ops, or mobile homes. Owning other properties does not disqualify you, but the exclusion applies only to your main home. In cases where parts of the home were rented or used for business, the exclusion may be partially reduced.
You generally do not need to report the sale of your primary residence if the gain is fully excluded under the Section 121 rules. However, if your gain exceeds the exclusion limit or if you receive Form 1099-S reporting the sale proceeds, you must report the transaction on IRS Form 8949 and Schedule D to calculate any taxable gain.
For example, a married couple who purchased a home for $200,000 and sold it six years later for $700,000 has a gain of $500,000. Meeting the ownership and use tests, they can exclude the entire gain, resulting in no capital gains tax owed. Conversely, selling before meeting the two-year residency requirement may lead to taxable gain.
To minimize taxes, keep detailed records of purchase prices and home improvements, ensure you meet the two-out-of-five-year rule, and consult a tax professional for complex situations like partial rentals or business use. Remember, losses on the sale of a primary residence are not deductible.
Understanding these tax rules avoids surprises and helps you maximize your home’s sale benefits. For further details, refer to IRS Publication 523, “Selling Your Home,” and consider reviewing related entries on capital gains and the Section 121 exclusion available on FinHelp.
