Selling a principal residence often opens doors to the biggest tax benefit of all-the home sale capital gain exclusion so that you don’t really have to pay taxes on a bunch of profit realized from the sale if you meet certain requirements.
Understand the $250,000/$500,000 home sale exclusion
The IRS affords eligible homeowners the opportunity to exclude gains of as much as $250,000 from the sale of their primary home. If married and filing jointly, that exclusion increases to $500,000. This means if your gain from selling your home falls under these thresholds, you may not owe any capital gains tax.
Meet the ownership and use tests
You must satisfy both the ownership and use tests:
- Ownership test: You must have owned the home for at least two years during the five years before the sale.
- Use test: You must have lived in the home as your main residence for at least two years during the same five-year period.
These two years of ownership and use don’t have to be continuous, and they can occur at different times within the five-year window. However, both tests must be satisfied within the five years leading up to the sale date.
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Be aware of the two-year rule limit
You are not entitled to the exclusion for the sale of a home for which the exclusion was used no later than two years prior. Some life events may qualify exceptions, but the acute reality is that the IRS only has one tax-free home sale every two years.
Know when you must report the sale
If you receive a Form 1099-S (Proceeds from Real Estate Transactions), you must report the sale-even though the entire gain is excluded. Further, if any portion of your gain is taxable, you must file Schedule D and Form 8949 with your federal tax return.
Special rule for military and certain government employees
If you or your spouse is on qualified official extended duty-such as serving in the Uniformed Services, Foreign Service or from the intelligence community-you can suspend the five-year period for up to ten years. You must be stationed at least 50 miles from your home or be living in government housing under official orders to be eligible. This development opens windows for you into meeting the ownership and use requirements.Think about the Installment Sale Option
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When you sell your home without a lump sum upfront but receiving payments gradually, that means you have done installment sales for that property. You can still enjoy exclusion under Section 121 even with selling a home using the installment method with respect to spread capital gain over several years. Just be sure to report income on Form 6252 since all exclusion limits apply.
Check with IRS publications for the details
Refer to Publication 523 (Selling Your Home) and Publication 537 (Installment Sales) for more specific guidelines. These documents contain worksheets, examples, and thorough explanations showing how to make the most of this important tax benefit.
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