Homeowners selling their homes have several different tax rules to consider. The U.S. Internal Revenue Service (IRS) provides a $250,000 tax break for single homeowners. Homeowners who seek to make a $250,000 profit can take the entire amount, tax-free and avoid any capital gains taxes under IRS’ special tax break rules. The tax break only applies in specific situations. Married taxpayers may take advantage of a $500,000 exclusionary rule.
Total Exclusion Capital Gains Law
The IRS changed the tax laws for residential real estate homeowners in 1997. Previously, homeowners were only able to roll their profits into a new home to avoid being taxed or to take a one-time tax-free real estate profit.
For this benefit to apply, the capital gains rules provide very specific limitations. First the property must not be used for investment purposes and the property must be considered to be the taxpayer’s primary residence. The IRS requires the taxpayer to have owned it for at least two out of the five years immediately preceding the sale date.
The benefit is increased to $500,000 for joint filers. The IRS treats jointly titled property the same way it treats property owned individually. If the taxpayer’s new spouse sold her condo one month prior to the purchase of the new home, then the taxpayer and her husband must live in the new home for at least two years prior to selling it tax-free.
Partial Exclusion Capital Gains Law
The IRS allows partial tax-free treatment for homeowners selling their residences for employment or health-related reasons. The homeowner may prorate the profit and receive tax-free treatment. The IRS uses mathematical calculations to determine the amount of profit that may be pro-rated.
For example, if the taxpayer only lived in the home for 12 of 24 months (two-year period) before being transferred to another job, then the taxpayer’s total occupancy would be 12/24. The IRS will multiply the .5 by the $250,000 amount to determine the exclusionary amount ($125,000 in this case). Thus, the taxpayer may exclude $125,000 from capital gains taxes.
Military Capital Gains Law
Military personnel under military redeployment orders are exempt from the federal two-year requirement. Military servicemen may qualify whenever they are redeployed without having to meet the two-year test.
Sale of Land for Capital Gains Purposes Law
The favorable tax treatment only applies to raw land if the land is next to a parcel of land the taxpayer owns and is lived in by the taxpayer. The vacant land must have been owned and used as her principal residence (extension of it). Furthermore, the IRS requires her to have met the two-year test earlier or later (only one may be taken every two years).
Cancellation of Debt
If the mortgage on the home is written off by the lender, then the IRS requires the taxpayer to treat the unpaid portion as ordinary income. Cancellation of debt is treated as income according to the federal regulations. Special rules apply to insolvent and bankrupt homeowners. Although banks foreclosing on the home are technically selling the homes, these homeowners may still have to report discharged debt.
Jill Stimson has worked in various property management positions in Maryland and Delaware. Stimson worked for the top three property management companies in the commercial industry and focuses her career on property building logistics and tenant relationships. She holds a Juris Doctor and a Bachelor of Science in psychology.