Do I Have to Pay Taxes on the Sale of My House? It Depends…

Principal Residence Exclusion

…Depends on what?

Among other things, on how long you’ve owned your home and whether it’s your principal residence. Generally, if you profit from the sale of property you have to pay capital gains tax on that profit. However, tax law states that if you’ve lived in your house for at least two of the last five years, some or all of the gain generated from the property sale may be free from tax.

English, please.

If you sell your principal residence, you might not have to include the gain on the sale as a capital gain on your tax return.

Wait – what’s a principal residence?

It is the home in which a person lives most of the time, whether they own it or rent it.

What’s the catch?

The amount of gain excluded from gross income shall not exceed $250,000 (or $500,000 if you’re filing a joint return). Also, the exclusion of income rule above can only be applied to one sale or exchange every two years. So if you’re flipping houses for investment purposes, don’t count on the exclusion to bail you out.

Here’s an example:

Say you buy a home for $300,000. You live there for one year, and then go abroad for two years, and rent it out. When you come back, you live there another year, and then you decide you’re a hot-shot and want to upgrade. The market boomed while you’re away and you sell the house for $500,000, meaning you had a gain of $200,000 on the sale. Generally, this would be a capital gain (subject to capital gains tax) that would need to be included on your tax return. However, because of the $250,000 gain exclusion, and since you lived there two years of the last five (in this case, one year at the beginning and one year at the end of the four-year period), you don’t have to include the gain.

How much can this save me?

Again, it depends (on where you live & how much you make). But assuming you live in New York and make $100,000 a year, it would have saved you approximately $47,600 in capital gains tax ($200,000 * 15% federal capital gains tax rate + $200,000 * 8.8% New York capital gains tax rate). Not bad.

Very interesting… Anything else?

Well, recently, the IRS made an interesting ruling. A married couple was entitled to a reduced exclusion of gain on the sale of their condo, even though they hadn’t lived there for two years. How come? They had a second child, and needed to upgrade to a larger home before they reached the two year minimum. The IRS determined that the suitability of the condo as their principal residence materially changed as a result of unforeseen circumstances (birth of said second child), which was the primary reason for the sale. Thus, they qualified for the reduced exclusion. Pretty neat, actually.

So what do I do now?

Give us a call. We can help analyze your potential sale and whether you qualify for the exclusion as well as whether you have any “unforeseen circumstances” that might work in your favor.