Selling your home: the $250,000 / $500,000 exclusion

Most people who sell a house owe nothing and report nothing. The exclusion is decided by dates, and the gain by records, so a preparer asks two questions: how long did you own and live in the home, and what did you put into it? The limit is the same whether you have owned the home for three years or thirty, so for long-time owners the second question is the one that matters.

The basic rules

To exclude the full amount, three tests must be met on the date of sale.

Ownership: two of the last five years. You owned the home for at least 24 months during the five years ending on the date of sale; the months do not have to be in a row.

Use: two of the last five years. You lived in it as your main home for at least 24 months in that same five years. Short absences, like vacations, count as time living there. The two years of ownership and the two years of use do not have to be the same two years.

Once every two years. You have not excluded gain on another home sale in the two years before this one.

Pass all three and up to $250,000 of gain is excluded, or $500,000 on a joint return if either spouse meets the ownership test, both meet the use test, and neither used the exclusion in the past two years.

The home has to be your main home: a house, condo, townhome, mobile home or houseboat you actually live in most of the time. A vacation cabin or second home does not qualify. And the rule only runs one way: if you sell for less than you put into it, the loss is not deductible, because a home is personal-use property.

Figuring your gain

Gain is not the sale price minus what you paid. It is the amount realized minus your adjusted basis, and good records can shrink it a lot.

Selling before two years: partial exclusions

If you do not meet the two-year tests, or used the exclusion within the last two years, you may still get part of it, if the main reason for the sale was a change in workplace, your health, or something you could not have foreseen. The IRS lists specific events that qualify automatically (Publication 523); anything else is judged on the facts.

A work-related move. You took or were transferred to a job at least 50 miles farther from the home than your old job was (old job 15 miles away, new job 65 miles away qualifies), or you had no job and started one at least 50 miles from the home. The same goes for your spouse, a co-owner, or anyone else who lived there.

A health-related move. Moving to get or give diagnosis, treatment or care for yourself or a family member: parent, child, grandchild, sibling, in-law, aunt, uncle, niece or nephew. Or a doctor recommended the move because of your health. Again, a spouse, co-owner or other resident counts.

An unforeseeable event. The home was destroyed or condemned, or had a casualty loss from a disaster. Or you, your spouse, a co-owner or another resident died, divorced or legally separated, had twins (or more), became eligible for unemployment, or could no longer pay basic living expenses because of a change in employment. Or an event the IRS has named in published guidance.

Other facts and circumstances. The situation arose after you bought and moved in, you sold soon after, and you could not reasonably have anticipated it: real trouble paying for the home, or a home that became significantly less suitable for your family for a specific reason. These are judgment calls; keep the documents that show why you sold.

The regulations also name reasons that do not qualify: traffic noise on a busy road, wanting a bigger house after a promotion or a raise, a windfall such as an inheritance or lottery winnings, or a nicer home becoming affordable because mortgage rates fell. Beyond the automatic list, the IRS has allowed partial exclusions in private letter rulings for a remarriage that created a blended family needing more room, the adoption of a child, a second child when the spare bedroom was a home office, an elderly parent moving in to care for an ill adult child, an adult child moving back home after a divorce, a sale after an assault or a burglary, and, despite the road-noise rule, airport noise. A letter ruling binds the IRS only for the taxpayer who asked, but they show where the line is.

How much

The exclusion is prorated, not the gain. Take the shortest of three periods, the time you lived in the home during the five years before the sale, the time you owned it, and the time since you last used the exclusion, divide by 24 months (or 730 days), and multiply by $250,000. On a joint return, do it for each spouse and add the two. Someone single who lived in the home for 12 months before a job transfer gets 12/24 of $250,000, or up to $125,000 of excluded gain, which usually covers everything after a short ownership. If you used the exclusion 18 months ago and must sell again for one of the reasons above, this sale’s limit is 18/24 of the full amount. Without a qualifying reason, and without the two years, the exclusion is zero.

Marriage, divorce and the death of a spouse

Life changes are where the rules most often help, and where opportunities are most often missed.

After a spouse dies. Two rules work together. First, a surviving spouse who has not remarried can still use the full $500,000 exclusion if the home sells within two years of the death; after that it drops to $250,000. Second, and usually bigger, the half of the home that belonged to the spouse who died gets a new basis equal to its value on the date of death, so the survivor’s basis is their own half of the cost and improvements plus half of the date-of-death value. On a home bought long ago, that step-up removes half the gain outright, and the exclusion handles the rest. (In a community property state the whole home steps up; Colorado is not one.)

Divorce. A transfer of the home between spouses in a divorce is not taxable. If you move out and your former spouse keeps living there under the divorce agreement, you are treated as still using it as your home, so you may still qualify when it is eventually sold.

Getting married. If only one spouse qualifies, the couple gets $250,000, not $500,000. Two people who each sell a qualifying home can each exclude $250,000.

Inherited homes. A home you inherit gets a basis equal to its value at death, so a prompt sale usually produces little or no gain, and the exclusion is not needed. (See when a loved one dies.)

Military and foreign service. Members on qualified official extended duty can suspend the five-year test for up to 10 years, so a home left behind on orders can still qualify.

Moving to assisted living. If you become unable to care for yourself, time in a licensed care facility counts as living in your home, as long as you lived there at least one year in the five before the sale.

Rental and home office use

A home that was ever rented out or used for business can still qualify, but part of the gain may be taxable.

Depreciation comes back. Any depreciation you claimed, or could have claimed, after May 6, 1997, for a home office or rental use is taxed when you sell, at up to 25%; the exclusion does not cover it.

Renting before you move in. If you rented the home out before making it your main home, years of rental after 2008 are “nonqualified use,” and a matching share of the gain is taxable.

Renting after you move out. Renting it out after you leave does not reduce the exclusion, as long as you sell within three years of moving out, so you still meet the two-out-of-five test.

A home from a 1031 exchange. If you got the home in a 1031 exchange, you must own it for five years before the exclusion applies at all.

Reporting the sale

If your whole gain is excluded and you do not receive a Form 1099-S, you generally do not report the sale; title companies often skip the 1099-S when you certify at closing that the gain is fully excludable. If you do receive one, or any gain is taxable, the sale goes on Form 8949 and Schedule D, with the exclusion shown as an adjustment. Keep your closing statements and improvement records for at least three years after filing.

Bills to double the exclusion and index it to inflation, or to end the tax on home sales altogether, have been introduced but have not moved out of committee.