IRS mandates that to be eligible for the exclusion, you must have owned your property for at least two of the most recent five years and used it as your primary home for at least two of the most recent five years before the date of sale. Imagine that you've been the proud owner of your home and a resident there for the last three years. After the sale, your basis in the property is determined to be $205,000, even though it was sold for $250,000. You will have a gain in equity equal to $45,000.
Because your $45,000 gain is far lower than the $250,000 exclusion to which you are entitled as a single taxpayer, you should not be required to make any federal capital gains tax payments. Your increase in capital value is exempt from taxation as a result.
Other Rules and Loopholes
The exclusion provided by Section 121 cannot be used only once. If you live in the home and own it throughout the relevant period, you are exempt from paying any capital gains tax on the profits of any sale of your primary house that takes place every two years. If you want to comply with these laws, you can't claim the exclusion more often than once every two years. A few more things may get in the way of your application, but they're not very common. You can't have purchased the property via a 1031 exchange for a like-kind property during the last five years, and you can't be liable for the expatriate tax either. These are just two examples.
Partial Exclusions
Even if individuals sell their homes before satisfying the two-out-of-five-years requirement, some taxpayers may still be eligible for a partial exclusion of the profits from selling their homes. If a taxpayer has to sell their home because of a move for employment, health reasons, or other unanticipated circumstances, they may exclude a part of their capital gains from their taxable income under the provisions of the tax law. Examples of things that could qualify for a partial exclusion include the following:
If you've only been living in your house for a year when your company moves you to a job in another city, the sale of your home will be work-related and not something you choose to do of your own will since you will be required to relocate for the position. You won't have to pay a significant amount more in taxes, but you won't be able to take advantage of the whole $250,000 exclusion.
If you were in residence for a year, you fulfilled the requirement of living in your house for half of the needed period. Therefore, you would need to multiply 0.5 by the whole amount of $250,000. As a direct consequence, you can exclude a profit of up to $125,000. You will only be responsible for paying capital gains tax on any profits that are more than this amount.
If they are compelled to relocate owing to service obligations, members of the armed forces are excused from the two-year rule for up to ten years, depending on the length of their obligation. They are required to report to a duty station that is at least 50 miles away from where they now reside.
Reporting the Gain
If you are sent a Form 1099-S, you must file a gain report on your tax return, even if the gain is not included in your annual income. Because the Internal Revenue Service also gets a copy of this informative return, you are required to advise that you are eligible to exclude the capital gain from your taxes. You can do this by filing a tax return, declaring the income, and claiming an exclusion. It's a bummer, but you can't deduct any capital losses from the sale of personal property, including your house—only losses on property utilized in a company or trade qualify for a tax deduction.
How to Avoid Capital Gains Tax on Home Sales
Do you want to reduce the tax you must pay when selling your house? On the sale of your home, there are methods to lower the amount of taxes you owe or even avoid paying them altogether. If you own your house and have lived in it for two of the preceding five years, you may be eligible to deduct from your taxable gain up to $250,000 (or up to $500,000 if you are married and filing jointly) of the profit on the sale of your home.
