Most of us don't sell our homes more than once every few years. And, as it turns out, by the time you do sell your home, you may find that the tax laws relating to such sales have changed substantially from when you bought the home. While Congress hasn't done a major revision of the tax laws relating to home sales recently, there has been a recent change that you may wish to take into consideration.
For clarity, the laws discussed in this report pertain to the sale of one's main home, also known as a principal residence. A main home may be a house, condominium, cooperative apartment, mobile home, or even a houseboat. If you divide your time between more than one home, there is no definitive, "bright line" rule that determines which one is your main home. Rather, your main home will be determined based on where you spend the majority of your time as well as on such factors as the location of your place of employment, where your family members' main home is, the address you use on your Federal and state tax returns, driver's license, automobile registration, and voter registration card, your mailing address for bills and correspondence, the location of your bank, and the location of any religious organizations and recreational clubs of which you are a member.
If you happened to sell a home before 1997, you may remember that in the past, sales of homes were tax-free as long as the sellers bought a new residence that cost more than their old home sold for. Essentially, this encouraged homeowners to "trade up" with regard to their homes over the course of their lives. Taking into account that many people prefer to move into a smaller home as they get older and their children grow up and move out, the law also provided that people over 55 could also claim a once-in-a-lifetime exclusion from capital gains tax on the sale of their home even if they replaced it with a less expensive home or chose not to purchase a new home at all. But these rules are no longer in effect.
The good news is that it no longer matters whether you replace your old home with a more expensive home or how old you are. Instead, the current law, sometimes known as the "Section 121 exclusion," allows sellers to exclude up to $250,000 of gain on the sale of a main home, or $500,000 for married couples filing jointly, if they meet the qualifications. In order to benefit from this exclusion, you must (a) meet the ownership test; (b) meet the use test; and (c) not have benefited from this exclusion in the preceding two years. The ownership test requires you to have owned the home for at least two years during the five-year period ending on the date of the sale, while the use test requires you to have lived in the home as your main home for at least two years during the five-year period ending on the date of the sale.
Note that you do not need to meet the ownership and use tests at the same time, nor do the two-year periods of ownership and use need to each be continuous. For example, suppose you rented a house on October 1, 2006 and lived there as your main home until September 30, 2007 . Then you purchased the home on October 1, 2007 , but moved out and rented it to another person for a year until September 30, 2008 . Then you moved back into the house on October 1, 2008 and lived there through September 30, 2009 . At that point, you would have two years of satisfying the ownership test, and two (non-consecutive) years of satisfying the use test, and you would be eligible to use the exclusion from gain.
A married couple filing a joint tax return can exclude up to $500,000 of gain from the sale of their main home if they meet all of the following criteria:
1. Either spouse meets the ownership test;
2. Both spouses meet the use test; and
3. Neither spouse excluded gain from the sale of another home during the two years ending on the date of the sale.
Interestingly, if you are eligible to exclude all of the gain on the sale of your main home (which would require the gain to be less than $250,000, or $500,000 for married couples filing jointly), you do not even need to report the sale on your income tax return. The sale should be reported only if there is gain which cannot be excluded. In that case, you would list the sale on Schedule D of Form 1040, showing the full amount of the sales price and your basis in the home, followed on the next line by an indication of the gain you are excluding as a negative amount, described as the "Section 121 exclusion."
Effective in 2009, however, a new wrinkle has been added to the exclusion from gain rules. The new law prevents sellers from using the exclusion from gain with respect to the gain allocated to "periods of nonqualified use." A period of nonqualified use is a period of time on or after January 1, 2009 , in which the property was not used as the principal residence of the taxpayer, the taxpayer's spouse, or the taxpayer's former spouse.
In effect, the gain from the sale of the home is to be allocated proportionately based on the time the taxpayer owned the home. If a taxpayer owns a home for ten years in which the home increased in value by $200,000, but one of those years is a period of nonqualified use, then the taxpayer will be subject to capital gains tax on $20,000 of gain from the sale of the home - that is, 1/10 of the gain will be attributed to the period of nonqualified use and not subject to exclusion. (If the taxpayer meets the ownership and use tests, though, the taxpayer will still be able to exclude the remaining $180,000 of gain from tax, as that would be less than the available exclusion of $250,000, or $500,000 for married couples filing jointly.)
Certain time periods are excluded from being classified as periods of nonqualified use, however. As indicated previously, periods before the year 2009 are not treated as periods of nonqualified use. Furthermore, any time after the last date that you or your spouse uses the property as a main home is not considered a period of nonqualified use. For example, suppose that you have owned and lived in a house for at least two years. You then move out of the house and rent the house to someone else for a year, after which you sell the house. The year in which you were renting the house to someone else is not considered a period of nonqualified use, because it was after the last date that you used the property as a main home. Only if you moved back into the house before selling it would the period you rented the house be considered a period of nonqualified use.
In addition, certain time periods can be excluded if you or your spouse was absent from the home because one of you was serving in the U.S. armed forces, the U.S. Foreign Service, the U.S. intelligence community, or certain other government positions.
For further information about additional rules which may apply, or if you have questions about the tax consequences of selling your home, an attorney at The Law Offices of Marc J. Lane can advise you. Please contact Marc Lane in confidence via email at [email protected] or via telephone at (312) 372-1040.
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