You may be worried that selling your house could end up costing you a huge tax payment at the end of the year. However, Congress has provided an exclusion to your income for the sale of a principal residence, subject to certain limitations of course. This article has been prepared by a tax attorney at The McGuire Law Firm to provide information related to excluding gain from the sale of your home.
One of the key elements to the §121 exclusion is that the house must have been used as the taxpayer’s principal residence for at least two out of the past five years. The reasoning is that Congress intends to give taxpayers a break for housing since there is likely going to be a follow up purchase for another home. Unlike an investment property, a taxpayer who sells his home will still need a place to live, and by forcing the taxpayer to pay capital gains tax on the sale of the current home, this actually reduces the funds available to purchase a second home.
There is a limit to the gain that may be excluded depending on how a taxpayer files his or her returns. In the case of a single taxpayer, the gain exclusion is $250,000 but, in the case, where the taxpayer files married filing jointly, there is an exclusion of $500,000.
You may be wondering the requirements to qualify for the principal residence element. According to the treasury regulations, the principal residence requirement depends on the taxpayer’s facts and circumstances. This is particularly important in cases where the taxpayer has one or more home. The regulations under 1.121-1(b)(2) provide that if a taxpayer owns two homes and lives in both throughout the year, then the place that the taxpayer spends the majority of his or her time for the year will be used for the §121 exclusion.
Also, this income exclusion may only be utilized once every two years, under §121(b)(3).
There is an exception to the §121 requirements in the situation where a spouse is deceased prior to the sale. In the situation where one spouse satisfied the requirements of §121 and the surviving spouse has not remarried at the time of the sale of the home, they still may be entitled to an exclusion from income (See Treasury Regulation 1.121-4(a)(2) for an example).
With all of the concern about exclusion from income, you must take into account that your basis in your home may have changed since you purchased your home. In general, basis takes into account money that a taxpayer has already paid tax on so that any income received from a sale results in taxing the untaxed portion.
For example, if you purchase a house for $400,000, then your cost basis on the date of purchase will be $400,000. However, if you renovate the kitchen for $30,000, your new basis in the house will be $430,000. This will help reduce your gain upon disposition of the house later. Therefore, it is important to keep track of any home improvements you make along the way because this could help significantly reduce your tax liability in the future, especially where your renovations may increase your gain over the §121 exclusion threshold.
If you have questions related to the sale of your primary residence and excluding gain from the sale of your primary resident, you can contact The McGuire Law Firm to speak with a Denver tax attorney international tax attorney or business attorney regarding your specific facts and circumstances.