IRS Rules on Selling a Home and Tax Implications - Tips & Solutions

The Reason for Tax Implications of Selling a Home

The Internal Revenue Service (IRS) sets forth rules governing selling a home and tax implications. If you’re thinking of selling a home or currently have a home listed for sale, you should consider the tax implications of that sale before tax-filing time. While the IRS provides exclusions that limit or eliminate tax assessment on many home sales, the last thing you want to be surprised with at tax-filing time is a huge tax bill that you may have been able to avoid if you’re understood the tax implications of selling a home before you listed your home for sale.

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The Ownership Test for Selling a Home

In order to exclude all or part of the gain from selling a home, you must pass the ownership and use test. If you have owned the home for two years or more, you pass the ownership test. To pass the use test, you must have occupied the home for two years or more prior to the sale. The ownership and use tests are essentially in place to ensure that taxpayers are only allowed to exclude all or part of the gain from selling the family’s primary residence.

Second homes and vacation homes do not meet the ownership and use test; however, rental property may. If you moved back into the rental property and maintained it as your primary residence for at least two years prior to the sale, the home meets the ownership and use test. If you did not occupy the rental property for the two-year time period required, then the home is considered business property, and you are subject to capital gains tax on all of the profit from the sale. For this reason, many homeowners choose to reoccupy former rental property, if possible, in order to avoid paying capital gains tax on the sales profit.

Exclusion of Gain on Sale

If you meet the ownership test, you may exclude the gain on the sale of your home up to the limit set by the IRS, unless you have already taken an exclusion on the sale of a home in the two years preceding the current sale. As of 2010, single tax filers are allowed to exclude up to $250,000 in gain on the sale of a home and married tax filers are allowed to exclude up to $500,000 in gain. If your gain fails under the IRS allowed amount, there are no tax implications, and you do not have to report the sale of your home to the IRS.

Under specific circumstances, the IRS may allow you an exclusion from capital gains tax. If you are a member of the armed services, Peace Corps or an employee of the intelligence community, you may qualify for an exclusion from capital gains tax. Other exclusions include things such as the development of a mental or physical disability, job transfer, death of a spouse, divorce and multiple births from a single pregnancy. Before putting your property up for sale, you should review the IRS rules on selling a home and tax implications.

References

“Internal Revenue Service–Publication 523” (https://www.irs.gov/publications/p523/index.html)