Are you looking to sell your home? Then you may be able to take advantage of a major tax benefit!
You may be entitled to exclude $250,000 of gain from the sale of your personal residence. If you are married, you may be entitled to exclude $500,000 of gain!
In order to exclude this gain, you must meet 3 tests.
- Ownership Test. You must have owned the home as a principal residence for at least 2 of the 5 years prior to the sale. If married, either or both spouses can meet this test.
- Use Test. You must have used the home as a principal residence for at least 2 of the 5 years prior to the sale. If married, both spouses must meet this test.
- Frequency Test. The exclusion applies to only one sale every 2 years. If married, this test is not met if either spouse has claimed this exclusion within the past 2 years.
If both spouses do not meet the use and frequency test, then a portion of the exclusion may still be claimed. In this case, instead of being able to claim the full $500,000 exclusion, the couple would only be able to claim the $250,000 if one spouse meets all 3 tests.
Even if you do not meet these tests, you may be able to claim a reduced exclusion! A reduced exclusion is available if you sold your principal residence because of:
- A change in your place of employment;
- Health reasons; or
- Unforeseen circumstances.
There is a safe harbor rule defining what qualifies under each of these three exceptions.
Lets look at an example. In April 2014, John and Jane Smith purchased a small, 2 bedroom house for $500,000. In September 2015, Jane gave birth to twins and they decided that they needed a larger home to accommodate their larger family. In October 2015, with the help of a great realtor, the Smiths sold the same house for $800,000.
The Smiths have $300,000 of gain on the sale of their home. They are afraid they will have to pay taxes on the full $300,000, but they talk to a CPA and learn that they do not have to. Although they did not meet the 2 year ownership and use tests, they qualified for a reduced exclusion because the birth of multiple children from the same pregnancy is considered an “unforeseen circumstance.” Because they owned and lived in the house for 18 months, they are able to take a reduced exclusion of $375,000 which is enough to eliminate their entire taxable gain. They do not have to pay any tax on the sale and can use the extra $300,000 to buy a bigger house!