Prior to May 7, 1997, a taxpayer's primary residence was considered a capital asset, and the sale of the home was considered a taxable event. Whether the taxpayer owned the home for more or less than a year determined whether the profit or loss was taxed at the long-term or short-term rate. The Taxpayer Relief Act of 1997 changed all that, allowing homeowners to exclude in many cases profits from the sale of their primary residence from their reportable income.
Taxpayers may not have to include gains realized from the sale of their primary residence if they meet certain requirements, according to the Internal Revenue Service. The taxpayer must have owned the home for at least two years and lived in the home as her primary residence for at least two of the five years immediately preceding the sale of the property. The two years do not have to be consecutive. Also, the taxpayer must not have excluded the gain from the sale of another residence during the two years immediately preceding the sale of the property. Certain members of the U.S. Armed Forces are exempt from the five-year rule.
Single taxpayers may realize a gain of up to $250,000 from the sale of their primary residence without having to pay capital gains taxes, provided the sale took place after May 6, 1997. Taxpayers who are married and who file a joint tax return may realize a gain of up to $500,000 from the sale of their primary residence without incurring a tax obligation. There is no requirement that the profits from the sale of a primary residence be reinvested in another home to qualify for this exclusion.
The right to exclude profits from the sale of a home applies only to the taxpayer's primary residence. The sale of a second residence, or the sale of a home used as rental property, is considered by the IRS as a taxable event. Second residences are considered to be capital assets, and the sale of these properties must be reported on IRS Form 1040, Schedule D. A home that the taxpayer used as rental property may still qualify for the exclusion if the taxpayer lived in the property as his primary residence for a total of two years during the previous five years before the sale. Losses incurred when selling a home may not be deducted from the taxpayer's income.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.