Selling Your Home: How to Minimize the Tax on the Gain

The exclusion, and who qualifies

The IRS allows you to exclude up to $250,000 of gain on the sale of your main home, or $500,000 if you're married filing jointly. Most sellers who meet the ownership and use tests owe no tax at all on the sale. If you have a loss instead, it's treated as a personal loss and isn't deductible. If your gain exceeds the exclusion, or part of the home was used for business or rental, you'll have a taxable gain to report on Form 8949 and Schedule D.

Back to top

What counts as your principal residence

Your main home is generally the one you live in most of the time, and it doesn't have to be a traditional house. Houseboats, mobile homes, cooperative apartments, and condominiums all qualify. If you own two homes and split time between them, whichever one you actually live in more counts as your main home for these purposes, regardless of which one has appreciated more.

Back to top

Figuring your gain or loss

Start with the selling price: everything you receive for the home, including cash, assumed debt, and the value of any property or services received. Subtract selling expenses, commissions, advertising, legal fees, and loan charges you paid, to get the amount realized. Compare that to your adjusted basis; if the amount realized is higher, you have a gain, and if it's lower, a loss.

A few situations complicate this. Jointly owned homes sold on a joint return are figured as one taxpayer, but separate returns require each owner to figure their own gain based on their ownership share. Trading one home for another is treated as a sale and a purchase. A foreclosure or repossession is treated as a disposition, with the amount realized depending on whether you were personally liable for the debt, and can also trigger ordinary income if canceled debt exceeds the home's value. Transfers to a spouse, or a former spouse incident to divorce, generally trigger no gain or loss at all.

Back to top

Basis: your starting point

Your basis is generally what the home cost you, whether purchased or built, including your down payment, any mortgage debt, and certain settlement or closing costs. If you acquired the home some other way, gift, inheritance, trade, or from a spouse, different rules apply, generally using either the donor's adjusted basis or the home's fair market value at the time you received it.

Over time, your basis is adjusted. Improvements that add value or extend the home's useful life, an addition, a new roof, a finished basement, increase your basis. Ordinary repairs that simply maintain the home's condition don't. Certain items decrease basis instead, including depreciation claimed for business or rental use, insurance payments for casualty losses, and some tax credits claimed for the home. Keeping records of your purchase price, purchase expenses, and every improvement is worth doing as you go, since reconstructing them years later at tax time is far harder.

Back to top

The ownership and use tests in practice

To claim the exclusion on a sale, you generally need to have owned the home for at least two years and lived in it as your main home for at least two years, both within the five-year period ending on the sale date. The two years don't need to be continuous, and short absences like vacations still count as periods of use even if you rented the home out during that time. You also can't have excluded gain on another home sale within the two years before this sale.

If you owned and used the home for less than two years, a reduced exclusion may still be available in specific circumstances: a change in your place of employment, a health-related move, or certain unforeseen circumstances like a natural disaster or job loss. The reduced amount is calculated proportionally based on how much of the two-year period you actually met.

Back to top

Special situations

Married couples filing jointly can exclude up to $500,000 if either spouse individually meets both tests, not necessarily both spouses. A surviving spouse is considered to have owned and used the home for any period the deceased spouse did. If your home was destroyed or condemned, any resulting gain, including from insurance proceeds, still qualifies for the exclusion. Using part of your home for a home office doesn't disqualify the sale from the exclusion, except that you can't exclude the portion of gain equal to depreciation claimed for that business use after May 6, 1997.

If you financed the purchase through a federally subsidized program, tax-exempt bond financing or a mortgage credit certificate, you may owe a separate recapture tax when you sell, even if your gain itself is fully excluded. That recapture tax is calculated independently of the exclusion rules discussed above.

Back to top