Taxes in the form of capital gains are due when you sell your home and you make a profit. As an example, if bought your home for $100,000 and sell it for $150,000, then you realized a $50,000 capital gain, which is taxable profit.
You can reduce your taxable profit with deductions, and there is more to say about deductions, but this post will focus on a large exclusion, the IRS Code Section 121 exclusion.
With the Section 121 exclusion, if you sell your primary residence for a profit, $250,000 (if you are single) or $500,000 (if you are married) of the profit may be excluded from capital gains tax.
To qualify for the Section 121 exclusion, the property must be your “principal residence.” To qualify as your principal residence, the property must meet the following:
- You owned the home and used it as your primary residence for at least two of the five years before the sale of the residence. The two-year residency requirement does not need to be fulfilled in consecutive years, just cumulative months.
Example: Alfred purchased his home for $500,000, lives in the home for one year, then moves out, rents the home for three years, then moves back for the fifth year. At the end of the fifth year, Alfred sells the home for $700,000, realized a $200,000 capital gain. Alfred qualifies for the exclusion, whether he is married or single, because Alfred lived in the home for two of the five years prior to sale and the amount of the realized capital gain is less than $250,000. - You did not purchase the home through a 1031 like-kind exchange in the past five years.
- You did not exclude the gain from the sale of another residence two years prior to the sale of this residence.
What if you own and live in more than one home? If you own and live in more than one home, then the home you spend the most time at will likely qualify as your principal residence.
What if you live in a non-traditional home? Mobile homes, apartments, and boats can qualify as your principal residence if they have a kitchen, bathroom, and sleeping space.
Can you partially qualify for the Section 121 exclusion? If you do not qualify for the Section 121 exclusion, you may still qualify for a partial exclusion under certain circumstances. You may qualify for a partial exclusion if you need to sell your residence to relocate for work (work must be at least 50 miles from the residence you are selling), because of health issues, or due to other unforeseen circumstances.
I am not an accountant, and it is important to speak with your accountant about tax matters. The purpose of this post is to make your aware of the Section 121 exclusion. If you think you might qualify for the Section 121 exclusion, speak to your tax professional to be sure.