In most instances you can can sell your primary residence without incurring any tax liability. You can make up to $250,000 in profit if you’re a single owner, twice that if you’re married, and not owe any capital gains taxes.
There are a few requirements to avoid owing any tax. First, the property you’re selling must be your principal residence. That means you live in it. This tax break doesn’t apply to a house or other property that you have solely for investment purposes. In those cases, the usual capital gains rules apply.
You can, however, turn a rental house into your primary residence, making the sale of it eligible for the exclusion. This is accomplished when you meet the IRS use and ownership tests: You own and live in the home for two out of the five years before the sale. Your actual habitation of the home doesn’t have to be sequential. The IRS lets you aggregate your time living in the house to meet the two-year residency requirement.
You don’t even have to live in the house at the date of sale. The flexibility of the use test means you could live in your house for a year, rent it for two, move back in for another year and rent it again the year before you sell. Since during those five years you owned and lived in the property for two years, you meet the use and ownership tests.
While technically there’s no limit on the number of homes you can sell and thus reap tax-free gain, each sale must be at least two years apart. That still leaves you room to make some money on several properties. You can sell your residence this year, pocket any gain within the tax limits and buy a new residence. Two years later, you can do the same thing, again and again every two years.
While a husband and wife get double the exclusion of single home sellers, couples also have some additional considerations when it comes to determining whether their sale is tax-free.
Either spouse can meet the ownership test. For example, the IRS says it’s OK if you owned the home for the last two years, but you just added your new husband to the title when you got married six months ago. Since you owned the residence for the requisite time, as joint filers you have no problem meeting the ownership test even though your husband wasn’t an official owner for that long.
However, both husband and wife must pass the use test; that is, each must live in the residence for two years. But the shared use doesn’t have to be while you file jointly. If you and your now-husband shared the home for 1½ years before tying the knot and then six months as newlyweds, the IRS will allow you to claim the exemption. But if he didn’t move in until the wedding day, you’re out of tax-exclusion luck. The two-year eligibility rule applies to both spouses.
Under this couple requirement, if either spouse sold a home and used the exclusion within two years of the sale of any jointly-owned property, the couple can’t claim the exclusion. That means if one spouse sold a home a month before the wedding, then you’ll have to wait two years after that property’s sale date before you can dispose of your shared marital residence tax-free.
If you and your spouse met the use and ownership tests, as well as the two-year previous-sale time limit, it’s time to do the math to determine if any capital gains taxes are due upon the sale.
It’s your gain, or profit, that determines the size or lack of a tax bill. In fact, you can sell your house for $1 million and still not owe Uncle Sam as long as the profit portion was not more than $250,000 or $500,000, depending on your filing status. If you can exclude all the gain, then you owe no taxes. You are permitted to add the cost of any capital improvements to the purchase price to offset the gain.
Even if you don’t meet all the home-sale exclusion tests, your tax break might not be totally lost.
When an owner sells his house because of special conditions, such as a change in health, employment or unforeseen circumstances, he’s eligible for a prorated tax-free gain.
Members of the military also get special home-sale consideration. Because of redeployments, soldiers often find it hard to meet the residency rule and end up owing taxes when they sell. But a law change in 2003 now exempts military personnel from the two-year use requirement (for up to 10 years), letting them qualify for the full exclusion whenever they must move to fulfill service commitments.