In some areas it is a seller’s market and big profits from home sales are likely. Great if you are a salesperson. But what about taxes?
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For all of the obvious reasons, many suburban real estate markets are brand new. Big profits from home sales are likely in these sellers’ markets. Great if you are a salesperson. But what about taxes?
If you’re selling your home for a healthy profit, the federal income tax exemption from home sales can be one of the most valuable breaks on the books. You can potentially exclude up to $ 250,000 in home sales income or up to $ 500,000 (not paying federal income tax) if you are a married co-applicant. Good.
Here is the first part of our two-part series on how to take advantage of the benefits.
Receive exclusion qualification rules
Singles can exclude home sales profits of up to $ 250,000, and married couples filing together can exclude up to $ 500,000. However, you must pass the following tests to be eligible.
You must have owned the property for at least two years during the five year period ending on the sale date. Two years mean periods totaling 24 months or 730 days.
You must have used the property as your primary residence for at least two years during the same five year period.
Ownership and usage times do not have to overlap. For example, you could rent a house and use it as your primary residence for years 1 and 2, and then buy it and rent it to others for years 3 and 4. Then, if you sold the place in year 5, you would both pass the ownership and use tests and qualify for the profit exclusion privilege. Who knew?
Joint filer test
To qualify for the major exclusion of $ 500,000, at least one spouse must pass the owner test and both spouses must pass the usage test.
What counts as a main residence?
This can be a good question if you own and occupy multiple apartments. The general rule is that your primary place of residence for the year is the one you spend most of that year. As per IRS regulations, other relevant factors may include:
The postal address that will be used for your invoices and correspondence.
The address listed on your income tax return, driver’s license, and car and voter registration cards
Where you keep your bank accounts
Where you have religious affiliations and club memberships.
Where family members live.
Example 1: You have a house in New York and another in Florida. From 2016 to 2020 (five years), you will spend seven months in New York each year and the remaining five months in Florida. They are selling both properties in January next year. Unless otherwise specified, the New York home is your primary residence and you can only claim the Income Exclusion Privilege for that property. This is despite the fact that you spent approximately 25 months in Florida in the five year period ending on the sale date (more than the required 24 months).
Regardless of what you might infer from the previous example, the following example shows that it is indeed possible to pass ownership and use tests for two residences at the same time.
Example 2: You own a house in Michigan and another in Arizona. You will live in Michigan for 2017 and 2018. In 2019 and 2020, you will live in Arizona. If you sell either house in 2021, you will qualify for the exclusion of profits privilege because you will pass ownership and use tests on both houses. However, if you sell both of them in 2021, you won’t be able to claim exclusions from both sales. This is prohibited by the anti-recycle rule explained immediately below.
Note the anti-recycling rule
The other key qualifying rule for the Home Sale Exclusion Privilege is as follows: The exclusion is generally only available if you have not excluded a profit from a previous sale that occurs within the two year period ending on the date of the later sale. In other words, the exclusion of profits privilege generally cannot be “recycled” for two years since you last used it.
For married couples, the larger exclusion of $ 500,000 applies only if neither spouse excluded a gain from a previous sale within the two-year period.
Example 3: You sold your previous primary residence on July 1, 2019 and excluded the profit on your Form 1040 for 2019. Before selling this house, you bought another property and used it as your new primary residence on January 1, 2019 (six months earlier). . You are selling your second primary residence on March 1, 2021 and you think you will qualify for the blackout break on this sale too. Not correct. While you pass ownership and use tests with flying colors, the March 2021 sale breaks the anti-recycling rule because it is within two years of the July 2019 sale. Therefore, you cannot rule out a profit from the 2021 sale.
However, if your profit from the 2021 sale is greater than the profit from the 2019 sale, you can change your 2019 return and select the changed return to forego the profit lockout pause for sales that year. Then you can claim the profit exclusion break for the more profitable sale in 2021.
The final result
As I said at the beginning, the home sale exclusion agreement can be one of the most valuable personal income tax breaks on the books. In my next column, I’ll go into more detail about how married homeowners can make money and how you might be eligible for reduced exclusion if you don’t meet all of the eligibility rules for full exclusion. Stay tuned.