Capital Gains Tax on Home Sales

If you sold or are thinking of selling your home in the near future and you owned and lived in it for a minimum of two years total, you can exclude up to $250,000 in capital gains tax from the sale of a primary residence (married couples can exclude up to $500,000).

To qualify for the capital gains tax exclusion, you must have owned the home for at least two years (referred to as the ‘ownership test’) lived in the home for a cumulative total of two years (the ‘usage test’ and the two years do not need to be consecutive) out of the five years that you owned the home.  This is to prove that the home was your principal residence.

This 2-out-of-5 year rule may be used to exclude your capital gains each time you sell or exchange your main home and typically, you can claim the exclusion only once every two years.  However, there are exceptions to this capital gains tax rule that enable you to possibly deduct a portion of the capital gain if you had to sell your house because of a job relocation, because of poor health or medical necessity or for other hardships or unforeseen circumstances.

Make sure you have a letter from your physician detailing the medical condition in the event that you are audited or asked to provide evidence to support the capital gains tax exclusion.  The IRS is very specific about what they consider unforeseen circumstances in Publication 523 as “the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.”   Examples of unforeseen circumstances that qualify for capital gains exclusion to the two year rule include the following:

• Natural disasters
• Acts of war
• Acts of terrorism
• Change in employment or unemployment that left you unable to meet basic living expenses
• Death
• Divorce
• Separation
• Multiple births from the same pregnancy

Active military personnel on qualified extended duty in the U.S. Armed Services, Foreign Service, or the intelligence community (sales or exchanges after December 20, 2006) may suspend the five-year test period for up to 10 years for the purpose of reporting capital gains tax on real estate sales. This capital gains tax provision may be used for only one property at a time. Qualified extended duty is defined as being assigned to a duty station at least 50 miles from your former principal residence or residing in government housing under orders and the duty lasts for more than 90 days or for an indefinite period.

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