A Tax Strategy for Gain On The Sale Of Your Home
Will I Be Taxed On The Sale Of My Home?
Tax Strategy No. 116: Exclusion of gain on sale of your home – full and prorated exclusion.
Have you noticed the housing market boom? It is wild here in the RDU area of NC - as it is in many areas of the US. And there is good news. Tax rules allow you to exclude up to $500,000 ($250,000 if you are single) of gain on the sale of your home.
To qualify for the full exclusion, you must meet both an ownership test and a use test:
You're eligible for the exclusion if you have owned and used your home as your principal residence for at least two years out of the five years prior to sale.
You can meet the ownership and use tests during different 2-year periods.
You must meet both of these tests during the 5-year period ending on the date of sale. Generally, you're not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.
But wait, there’s more!
There is a partial exclusion loophole if you do not meet the rule above because you sold before the 2-year period.
This prorated gain exclusion equals the full $500,000 ($250,000 single) applicable amount multiplied by a fraction:
The numerator is the shorter of:
the total period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or
the period between the last sale for which you claimed an exclusion and the sale date for the home currently being sold.
The denominator for this fraction is two years or the equivalent in months or days.
The prorated exclusion loophole is only available when there is an early or premature sale. This prevents you from holding it for the entire 2 year period if the reason for the sale is:
Employment change,
Health reasons, or
Specific unforeseen circumstances.
Example: You have owned and lived in Home A as your principal residence for 11 months (are married and filing jointly). If you qualify under one of the exceptions listed above, you are allowed to exclude up to $229,167 ($500,000 × 11/24) of gain. That will go a long way toward diminishing or even eliminating a tax on the gain.
Employment Change
IRS rules say you are eligible for the prorated gain exclusion if the early sale is primarily due to a change in your place of employment. Or, you are a “qualified individual”, which I will call a “QI”, which is defined as:
the taxpayer (yes, that is you),
your spouse,
any co-owner of the home, or
any person whose principal residence is within the taxpayer’s household.
A premature sale is automatically considered to be primarily due to a change in place of employment if any QI passes the following distance test:
The distance between the new place of employment/self-employment and the former residence (the property that is being sold) is at least 50 miles more than the distance between the former place of employment/self-employment and the former residence.
(Almost any close relative of a person listed above also counts as a qualified individual. Any descendent of the taxpayer’s grandparent, like a first cousin, also counts as a QI.)
Health Reasons
If a premature sale is primarily due to health reasons, you are also eligible for the prorated gain exclusion if your move is to:
obtain, provide, or facilitate diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a QI
or
obtain or provide medical or personal care for a QI who suffers from a disease, an illness, or an injury.
Whenever a doctor recommends a change of residence for reasons of a QI’s health, the premature sale is automatically considered to be primarily for health reasons. Otherwise, the facts and circumstances of your situation must indicate that the premature sale was primarily for reasons of a QI’s health.
An early sale that is only helpful or beneficial to the general health or well-being of a QI will fail the test.
Other Unforeseen Circumstances
This is one of those difficult “facts and circumstances” rules.
The occurrence of an event that you could not have reasonably anticipated before purchasing and occupying the residence might qualify for the partial gain exclusion.
IRS has ruled that a sale that is largely due to a preference for a different residence or an improvement in financial situations will not qualify.
But wait, there’s more.
The Safe-Harbor Rule
If any of the following events occur while you own and use your principal residence, the partial exclusion will be deemed to apply due to unforeseen circumstances:
Your home is destroyed, stolen, condemned, or other involuntary conversions to the residence
A spaceship falling from the sky, natural or man-made disaster or acts of war or terrorism resulting in a casualty to the home
Death of a QI
QI’s loss of employment, making him or her eligible for unemployment compensation
QI’s change in employment or self-employment results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses
QI’s divorce or legal separation
The birth of twins, triplets, quadruplets, and other multiple births of a single pregnancy of a QI.
Refer to Publication 523 for the complete eligibility requirements, limitations on the exclusion amount, and exceptions to the two-year rule.
Tax Shelter Strategy No. 116: Exclusion of gain on sale of your home – full and prorated exclusion.
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*Updates and guidance are issued daily by governmental authorities. The information above may change with new laws and rulings.