Selling Your Home? How the $250,000/$500,000 Capital Gains Exclusion Works
Most U.S. homeowners can exclude a large gain from federal tax when they sell their main home. Here are the ownership and use tests, the exceptions and the traps.
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If your home has gained a lot of value, you may wonder how much of the profit the IRS will take when you sell. For many homeowners, the answer is none. Section 121 of the Internal Revenue Code lets you exclude a large amount of gain on the sale of your main home, as long as you meet a few rules.
The basic exclusion
You can exclude up to $250,000 of gain if you're single, or up to $500,000 if you're married filing jointly. Only gain above those amounts is potentially taxable.
The ownership and use tests
To qualify for the full exclusion, you generally must have:
- Owned the home for at least two years during the five years before the sale, and
- Lived in the home as your main residence for at least two years during those same five years.
The two years don't have to be consecutive. You also generally can't have used the exclusion on another home sale in the two years before this one. For the $500,000 joint exclusion, either spouse can meet the ownership test, but both spouses must meet the use test.
How gain is calculated
Your gain is roughly the sale price minus selling costs minus your adjusted basis. Your basis starts with what you paid for the home plus certain purchase closing costs. It increases with capital improvements like a new roof, an addition or a kitchen remodel, but not with routine repairs and maintenance. Keep receipts for improvements, because they directly reduce your taxable gain.
Partial exclusions for life changes
If you sell before meeting the two-year tests, you may still qualify for a reduced exclusion when the sale is mainly due to a change in workplace location, health reasons or certain unforeseen circumstances. The exclusion is prorated based on how much of the two-year period you met.
Common traps
- Depreciation recapture: if you rented out the home or claimed a home office, depreciation taken after May 6, 1997 generally can't be excluded and may be taxed when you sell.
- Periods of nonqualified use: time after 2008 when the home wasn't your main residence, such as when it was a rental before you moved in, can reduce the excludable gain in some situations.
- Second homes and investment properties don't qualify for the exclusion at all.
- State taxes: most states follow the federal treatment, but check your state's rules.
Reporting the sale
If your entire gain is excluded and you didn't receive a Form 1099-S, you generally don't need to report the sale on your return. If you received a 1099-S or your gain exceeds the exclusion, you'll report it on Form 8949 and Schedule D. Gain above the exclusion on a home held more than a year is taxed at long-term capital gains rates.
The bottom line
For most people selling a home they've lived in for at least two years, federal tax on the profit is limited or zero. Track your improvements, mind the two-year rules and talk with a tax professional before selling a home that was ever rented or used for business.
