There is often no tax consequence when you sell a home. If you incur a loss on the sale, you can’t deduct it from income. If you make a profit (capital gain) from the sale, it is often nontaxable. For the sale to be nontaxable, though, you must pass a couple of tests:
You must own the home for at least two years (ownership test), and
You must live in the home for at least two years (use test).
The ownership and use periods don’t have to be continuous. If you can show that you owned and lived in the home for either 24 full months or 730 days during the last 5 years, then you pass the tests.
Short, temporary absences for vacations or other seasonal absences, even if you rent out the home during your absences, are counted as periods of use.
If you and your spouse file a joint return and have a gain of less than $500,000, then the income is tax-free. For other qualifying filers, the gain must be less than $250,000. If your gain exceeds the income limit for your filing status, then only the excess amount is taxable. For example, if you and your spouse make a profit of $562,000, then only $62,000 is taxable.
You can claim the $500,000 exclusion on a joint return if all of the following are true:
You and your spouse are married and file a joint return for the year.
Either you or your spouse meets the ownership test.
Both spouses meet the use test.
Neither you nor your spouse claimed an exclusion on the sale of another home (after May 6, 1997) during the two-year period ending on the date of the sale.
If you can exclude the entire amount of the gain from a sale, you don’t need to report it on your tax return. If you need to report any gain, you must complete Schedule D.
You can use your HUD-1 settlement statements from both the sale of the residence and the purchase of the residence to help you determine the amount of gain or loss. You can also use documentation about any improvements.
A change in living conditions for you or your spouse, co-owner or resident, may result in a reduced exclusion. If you meet any of the conditions listed below, you may be eligible for a reduced exclusion amount even if you don’t pass the use and ownership tests:
A relocation because of a change in employment if the new job is at least 50 miles farther from the residence than the previous job.
Due to a change in either your health or place of employment (see the bullet above), you didn’t meet the ownership or use tests.
Unforeseen circumstances arose. Among other things, these can include employment changes, death, divorce, or multiple births from the same pregnancy.
You can’t exclude the gain on the sale of a home if you sold another home at a gain and excluded all or part of it during the two-year period ending on the date of the sale. If you can’t exclude the gain, you must include the entire amount in your taxable income.
If you meet the ownership and use tests, you can exclude the gain from the sale of a home that you rented or used for business. In addition, if you use part of your home to conduct business, you don’t need to allocate the gain to the business portion of the home.
A full exclusion applies upon the sale of the residence except for allowed and allowable depreciation taken since May 6, 1997. If you took depreciation deductions because you rented out your home or used it for business, you can’t deduct the part of the gain that is equal to any depreciation deductions that you took for periods after May 6, 1997.
You may use part of your property as a home and part of it for business or to produce income. Examples of such use are an apartment building in which you live in one unit and rent out the others, or a store building with an upstairs apartment that you live in.
If you sell the entire property, the transaction is considered the sale of two properties. You report the business portion on Form 4797 and you report any taxable personal portion on Schedule D. You can exclude the gain only on the portion used as a home. The sales price, expenses of sale, and adjusted basis of the property that you sold must be allocated between the personal portion and the business portion. You must attach a statement to your return showing the total selling price of the property and the method that you used to allocate the amounts between the two forms.