You are required to include in your taxable income any gains that result from the sale of a home. However, if the gain is from the sale of your primary residence, you may exclude up to $250,000 from your income if you're a single filer or up to $500,000 if you're married filing jointly provided that you meet certain requirements. These amounts are the maximum exclusion.
Keep reading to learn whether the exclusion applies to you and how to claim it.
Key Takeaways
- You may be subject to taxation on any gains realized from the sale of a home.
- Single taxpayers may qualify for an exclusion of up to $250,000 in gains from the sale of their principal residence; the exclusion goes up to $500,000 for married couples filing jointly.
- To qualify for the exclusion, the property must have been owned by you for two out of the prior five years and must have been used as your primary residence.
- The gains are reported on Form 8949 and Schedule D of your tax return.
- To be eligible, you must not have received a similar exemption from a property sale in the last two years.
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Eligibility for Gains Exclusion
As noted above, the Internal Revenue Service (IRS) allows homeowners to exclude from taxable income a certain amount of gains that result from the sale of their primary home. This is known as the Section 121 rule.
To be eligible to exclude up to $250,000 ($500,000 if you're married and filing jointly) in gains from the sale of your property, you must meet the following requirements:
- You must pass the ownership and use tests. This means that you must have owned the home for at least two years within the five-year period ending on the date when you sold your home. And, you must have lived in it as your primary residence for at least two of those five years. The two years do not have to be consecutive.
- You did not exclude from your income the gain from a sale of another home during the two-year period ending on the date of the sale of the home for which the exclusion is being claimed.
If you share ownership in the home but you and the other owner file separate returns, you may each exclude up to $250,000 from your income if you both meet the requirements listed above. Your portion of the gain is the percentage ownership you have in the home multiplied by the total gain from the sale.
For detailed information about the eligibility requirements for this exclusion, refer to IRS Publication 523, which also includes information about the reduced maximum exclusion for individuals who are not eligible to claim the maximum exclusion. You can access the full document on the IRS website.
How to Claim the Exclusion
Once you sell your home, you may receive a Form 1099-S: Proceeds from Real Estate Transactions from the lender, real estate agent, broker, or realtor. This form includes:
- The issuer's name and details, including their address, and taxpayer identification number (TIN)
- Closing date
- Property address
- Gross proceeds of the sale
According to the IRS, the full amount of the sale must be reported to the agency "even if the gain from the sale is excludable."
Make Your Claim
Taxpayers should use Schedule D: Capital Gains and Losses as well as Form 8949: Sales and Other Dispositions of Capital Assets to report the sale and claim the exclusion.
This includes those who can't exclude the entire capital gain from their income. Keep in mind that both of these forms go hand-in-hand and must be completed together and accompany Form 1040.
Advisor Insight
Steve Stanganelli, CFP®, CRPC®, AEP®, CCFS
Clear View Wealth Advisors, LLC, Amesbury, MA
Whether or not you are exempt from tax will depend on your filing status, the amount of the gain, and your occupancy status for the property sold.
Your gain is figured by determining your basis. Your basis consists of what you originally paid for the property plus certain closing costs at the time. Then you add in major home improvements, such as a new kitchen, etc. Also, add in the real estate transaction fees you paid.
To figure out the gain, take your sale price, and subtract the basis. If the difference is $250,000 or less (for a single filer) or $500,000 or less (for those filing jointly), you will not pay tax on any of your gains.
You will need to file a form with your taxes to document this. To best determine whether or not your sale is exempt, you may want to speak with a qualified tax planner.
How Do I Claim the Primary Residence Exclusion?
Your agent, broker, realtor, or lender will send you a Form 1099-S after the sale of your home goes through. This form will have the information you need to report the sale. The IRS requires that you report the amount, regardless of any excludable amount.
If you meet the eligibility requirements, use the information from Form 1099-S to report the sale on Form 8949 to calculate your gains. You can then fill out Schedule D. These forms must accompany Form 1040 when you file your annual tax return.
What Is the 2-Out-of-5 Rule for Capital Gains?
The 2-out-of-5 (or 2-5 for short) rule is commonly applied to the sale of a principal or primary residence. Also referred to as the ownership and use test, it states that a taxpayer must have owned the home for two of the last five years before the sale (they don't have to be consecutive) and must have used it as their principal residence for two of those years.
How Many Times Can I Exclude the Gain on the Sale of a Home?
You may only exclude the gain on the sale of a home using the Section 121 exclusion (the primary residence exclusion) once within two years. So if you used the exclusion when you filed your 2023 taxes, you cannot use it again on your 2024 taxes.
How Do I Avoid Paying Capital Gains When I Sell My Home?
While you may not be able to avoid paying taxes outright, the IRS gives taxpayers a tax break on the capital gains that result from the sale of their principal residence. The Section 121 rule allows single filers to exclude up to $250,000 and married couples who file jointly to exclude up to $500,000 in gains as long as they meet the 2-out-of-5 rule described above.
The Bottom Line
You have to report any profits that result from the sale of your home. But the IRS allows you to exclude a certain portion of those gains—up to $250,000 if you're a single filer or up to $500,000 for married couples who file jointly.
To qualify, the home must have been your primary residence and you must have owned it for two of the last five years leading up to the sale. This two-year period doesn't have to be consecutive.
Keep in mind that you can't use the exclusion more than once in a two-year period. Be sure to talk to a tax professional if you need more information about your tax liability.
