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Long Term Capital Gain on Sale of Primary Residence

Long Term Capital Gain on Homes

The IRS always treats the sale of a home as a capital asset transaction and requires you to report your long term capital gain on Schedule D if you own it for more than one year. However, for the long term capital gain on the sale of a primary residence, you still must calculate your capital gain, but you may qualify for the home gain exclusion—which allows you to eliminate any tax bill you incur on the sale of your primary residence. But if the home you sell is not the place where you ordinarily live, such as a vacation home, you must pay income tax on the gain.

Capital Gain Exclusion on Sale of Primary Residence

When your long term capital gain relates to the sale of a primary residence, the Internal Revenue Code allows you to exclude up to $250,000 of the gain if your filing status is single or head of household. However, if you are married and file a joint return, the maximum capital gain exclusion increases to $500,000. The first step is to calculate your gain on the sale of your primary residence as the amount you sell the home for less its tax basis—which is essentially the total cost of purchasing the home, including many of your closing costs. If you calculate a gain that otherwise increases your tax bill, you then need to evaluate your eligibility to eliminate all or some of your long term capital gain by satisfying the home gain exclusion’s ownership and use tests.

Home Gain Exclusion: Ownership & Use Tests

To exclude the long term capital gain on the sale of your primary residence, the IRS first requires that you live in the home as your primary residence for at least two years during the five-year period that ends on the date you sell the home. It isn’t necessary for the two years to be consecutive; you can move in and out of your home during the five-year period as long as the total number of days you use it as a primary residence adds up to two years. In addition, you must be the legal owner of the home for a total of two years during the same five-year period. However, this doesn’t need to be the same two years that you use the home as your primary residence. And if you plan on taking advantage of the $500,000 gain exclusion, your spouse must also satisfy the use test, meaning they must live in the home as their primary residence for two full years; but only one spouse needs to satisfy the ownership requirement to qualify for the higher exclusion amount.

IRS Reference: Publication 523 – Selling Your Home