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Capital Gains on Home Sales
Home sellers who qualify may choose to exclude up to $250,000 (or up to $500,000 on a joint return) of the gain from the sale of their main home. Any gain not excluded is taxable income.
Generally, gain on the sale is equal to the difference between the adjusted cost basis of the home and the sales price, less certain costs of sale (such as commissions, advertising costs and legal fees.) To determine the initial cost basis of your home, you start with the purchase price paid and add certain settlement costs. Costs which may be included in your basis are abstract fees, charges for installing utility services, certain legal fees, recording fees, survey fees, transfer taxes and owner's title insurance. You cannot include in your basis homeowner's insurance premiums and charges connected with getting your loan such as mortgage insurance premiums, assumption fees, the fee for a credit report and the cost of an appraisal required by the lender.
Once you have figured out your initial cost basis, you need to determine your adjusted cost basis. You add to the cost basis amounts you spent for any permanent improvements and additions to your property and any assessments for improvements that increase the value of a property, and amounts you spent to restore damaged property after a casualty. You must subtract from that basis any deductible casualty losses, any insurance payments you received or expect to receive from such loss, and any allowable depreciation resulting from business or rental use of your property. Further, if you postponed the gain from the sale of a previous home prior to May 7, 1997, the amount of that gain reduces the cost basis of your current home.
Once the amount of gain from the sale is ascertained, the question is whether you can exclude any of it from income. To qualify for the exclusion, home sellers must meet both an ownership and a use test. During the five-year period ending on the date of the sale, you must have 1) owned the home for at least two years and 2) lived in the home as your main home for at least two years. The periods do not have to be continuous. Married taxpayers filing jointly can exclude the gain if either spouse meets the ownership test and both meet the use test.
Home sellers who owned and lived in the property as their main home for less than two years may still qualify to claim an exclusion. If the sale resulted from a change in your place of employment or health, a prorated amount of the exclusion is available. For example, if you owned and lived in the home for eighteen months before a job move forced you to sell, then you could exclude up to $187,500 (3/4 of the maximum exclusion) of any gain on the sale.
If you used your home for business or to produce rental income, you may still qualify to exclude part of your gain from the sale. To do so, you must meet the ownership and use tests. However, the amount of gain equal to depreciation allowed or allowable for business use after May 6, l997 may not be excluded. If you can show that the amount of the depreciation deduction actually allowed was less than the amount allowable, then the amount you cannot exclude is the smaller number.
Finally, the gain you may not or choose not to exclude may offset capital losses from other asset sales.
Additional information about claiming the exclusion is available in IRS Publication 523, Selling Your Home.
Other rules apply to sales of rental property and second or vacation homes. For this information, see IRS Publication 544, Sales and Other Dispositions of Assets.
Updated November 11, 2002
