The tax code authorizes “exclusions” that allow home sellers to completely sidestep federal and state income taxes on sizable portions of their profits when they unload their principal residences. The profit exclusions are as much as $500,000 for married couples who file joint returns and $250,000 for single filers and couples who file separate returns, says Julian Block, an attorney and former IRS special agent.
Contrary to what many sellers mistakenly believe, the exclusions are not one-time opportunities. They can avail themselves of the exclusions as often as every two years.
The law allows a seller to qualify for the exclusion by satisfying two requirements:
- If the property is owned and lived in as a principal residence or main home for at least two years out of the five-year period that ends on the date of sale.
- The seller cannot have excluded the gain on the sale of another principal residence within the two years that precede the sale date.
The two years do not have to be consecutive; they can actually be off and on for a total of two full years.
What about short temporary absences for vacations or other seasonal absences? The seller can count them as periods of owner use. This holds true even if the owner rents out the property during the absences.
The IRS does not limit exclusions to sales of conventional single-family homes. A principal residence is considered to be any of the following:
- A condominium.
- A cooperative apartment.
- Portion of a multi-unit apartment building.
- A house trailer.
- A mobile home.
- A houseboat or yacht that has facilities for cooking, sleeping and sanitation.
- A vacation retreat where the owner moves into full time after retirement.
Another advantage: The location of a principal residence can be outside the U.S.
Partial profit exclusions. If the seller has another home within the previous two years or fails to satisfy the ownership and use requirements, they may be able to claim a partial exclusion.
Primary reasons for sales. The IRS permits sellers to avail themselves of reduced exclusions only when the primary reasons are health problems. Examples include when someone moves to a new school district for a special-needs child; changes employment; or certain unforeseen circumstances, broadly defined to include divorces or legal separations, or natural or man-made disasters that cause residential damage such as floods.
Another example may include someone that is single and has lived in a dwelling for just 12 months before moving to a new job in another city. The person can exclude a gain of as much as $125,000, 12 months divided by 24 months, or 50% of maximum allowable $250,000 exclusion.
Caution. Do not make assumptions about what you may be allowed to deduct. Discuss your situation with a tax professional.