Selling Your Home: How the $250,000 / $500,000 Exclusion Works

Selling Your Home: How the Home Sale Exclusion Works

Most people who sell their main home for a profit pay no tax on it, thanks to Section 121 of the tax code. But the rule has conditions, and a few situations create a real bill. The Home Sale Exclusion Calculator estimates the gain, the exclusion and the taxable part.

What is excluded

Single filers can exclude up to $250,000 of gain, and married couples filing jointly up to $500,000, provided both spouses meet the use test. The limits have not changed since 1997, even though home prices have risen sharply, which is why more sellers now have taxable gains.

The ownership and use tests

You must have owned the home for at least two of the five years before the sale and lived in it as your main home for at least two of those five years. The two periods can be different, and the years need not be consecutive. You can generally use the exclusion once every two years.

Calculating the gain

1. Start with the sale price.
2. Subtract selling costs, such as agent commissions and closing costs. The result is the amount realized.
3. Add up your adjusted basis: the price you paid, the buying costs and the cost of improvements that add value, such as a new kitchen or a roof, but not repairs.
4. Gain = amount realized minus adjusted basis.

Partial exclusion

If you sell before two years because of a change of job, a health problem or another unforeseen event, you may claim part of the exclusion: the number of months you qualified divided by 24, times the limit. After 12 months a single owner could exclude $125,000. The tool applies this when your months are below 24 and shows a note.

A worked example

A couple sells their house for $620,000 and pays $37,000 in costs. They bought it for $280,000 and spent $40,000 on a kitchen. The gain is $620,000 minus $37,000 minus $320,000, which is $263,000. With a $500,000 exclusion, all of it is excluded. If one spouse owned alone and filed as single, the exclusion would be $250,000, leaving $13,000 taxable, taxed at the long-term capital gains rate; at 15 percent that is $1,950.

What can still create a tax bill

• Depreciation claimed for a home office or rental use is not excludable and is taxed up to 25 percent.
• Periods of non-qualified use after 2008, when the home was not your main home, can reduce the exclusion.
• The 3.8 percent net investment income tax can apply to a taxable gain for higher incomes.
• A large gain in a high-price market, above $250,000 or $500,000.

Keeping records

Keep the closing statements for the purchase and the sale, receipts for improvements and dates for the years you lived there. The IRS can ask for them years later.

Using the tool well

Enter the numbers, switch between single and joint to see the effect and change the months to test a partial exclusion. The estimated tax uses the single rate you type, so choose the long-term capital gains rate that fits your income. The result is an estimate for planning and not tax advice.

Quick questions

What if I inherited the house? The basis is usually the value at the date of death, which can reduce your gain a lot; the tool lets you enter that value in the purchase box.

What if my spouse died before the sale? A surviving spouse can often still use the $500,000 limit if the sale happens within two years of the death.

Do I report the sale if the gain is fully excluded? Usually you do not, unless you received a Form 1099-S; ask your tax preparer.