Tax Savings Opportunities When Selling a Primary Residence

Overview of IRS gain exclusion rules when you sell a home

Are you thinking about selling your home or did you sell at some point during the year? During the early part of 2022, with real estate prices at all-time highs, many homeowners sold their homes at amounts higher than ever imagined. Additionally with some parts of the country still experiencing low inventory issues, even with now higher interest rates, some taxpayers could still realize substantial gains on the sale of their home, even if only owned a short time. Therefore, taxpayers should be aware of the rules surrounding gain exclusion on primary residences under Internal Revenue Code Section 121.

3 tests to qualify for the primary residence gain exclusion

If you have a gain from the sale of your home, single filers can potentially exclude gains up to $250,000 and married filing joint filers up to $500,000. To qualify for the exclusion, you must pass the following 3 tests.

1. The Ownership Test
   Taxpayer(s) must have owned the house for two of the last five years prior to the sale.
2. The Use Test
   This house must have been used as your primary place of residence for at least two of the past five years prior to the sale.
3. One-Sale-in-Two-Years Test
   Taxpayer must not have used the exclusion within the last two years.
   Note: Rule #3 only applies if gain exclusion was used. Taxpayers can still be eligible for gain exclusion if a primary residence sold within the last two years was at a loss.

These rules can get very complex in cases of divorce, inheritance, and other special situations (i.e. if the home was ever used as a home office). In cases such as this, you should contact your tax advisor to discuss your particular facts and circumstances.

Partial gain exclusion rules for special circumstances

In some cases, even when the above tests are not met, the Internal Revenue Service (IRS) still allows for partial exclusion of gain when the primary reason for selling the house relates to health, unforeseen circumstances or a change in place of employment.

The IRS defines these special situations as follows:

Change in Employment
Primary reason for the sale is a change in location of employment for the taxpayer, the taxpayer’s spouse, co-owner of the house, or a person whose principal place of abode is in the same household as the taxpayer.

Medical
Primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of a disease, illness, or injury for the taxpayer, the taxpayer’s spouse, co-owner of the house, or a person whose principal place of abode is in the same household as the taxpayer or any relative of such persons (as defined by the IRS).

Unforeseen Circumstances
Primary reason for the sale is as a result of an occurrence of an event that the taxpayer cannot reasonably anticipate before purchasing and occupying the residence.

For each of these above situations, the IRS provides “safe harbor” tests, that if met, automatically qualify you for the partial gain exclusion. For example, if the taxpayer’s new job is more than 50 miles farther away than the house being sold than was the prior job, the taxpayer automatically qualifies for partial gain exclusion under the Change in Employment Rule.

If you think you might qualify for full gain or even partial gain exclusion on the sale of your residence, we encourage you to reach out to your Keiter Opportunity Advisor. With taxes on long term capital gains up to 23.8% (plus state rates), the savings could be substantial.