As a homeowner, you are privy to extreme tax breaks from the federal government while you live in your home, as well as after you sell your home. In addition to tax and interest deductions, the Internal Revenue Servie will allow you to forgo paying the capital gains tax on home-sale profits from your primary residence in most circumstances, so long as you meet certain qualifications.
Most residential sales qualify for the home-sale tax break. To qualify, the property you sell must be your primary residence at which you lived at least two of the previous five years. You do not necessarily have to live at the residence two consecutive years or even at the time of the sale in order to qualify. In addition, you cannot take the tax exclusion if you or any other person on the deed of your home took advantage of the home-sale tax exclusion in the 24 months preceding the sale of the home, as you can only benefit from this tax benefit once every two years.
If you meet IRS qualifications for the home sale exclusion, you may be able to exclude the profit from the sell of your home from your federal income taxes. The federal government does not tax profits on your property if you gain less than $250,000 on the sale, or up to $500,000 for a married couple. If, however, you gain more than your profit cap, the IRS will tax the difference at the current capital gains rate. As of 2011, the capital gains rate is 10 percent for taxpayers in the lowest tax bracket and 20 percent for all other tax filers.
Some homeowners are under the impression that you must apply the profit from a home sale toward another home priced higher than the previous residence. Before 1997, this rule was the standard for most taxpayers. However, with the passage of the Taxpayer Relief Act of 1997, you are free to spend your home sale profits as you wish, so long as you meet IRS qualifications and profit limits. This means you can still apply your gains toward your next abode, or you can stash away the profits for a rainy day. Regardless of how you choose to use the extra cash, you will owe zero tax liability.
If you fail to meet IRS qualifications for your primary residence and must relocate due to uncontrollable circumstances such as a decrease in income or a job transfer, you may still qualify for a partial tax exemption on your home sale profits. Provided you have not used the home sale exclusion in the past two years and the home you sell is your primary residence, your profits may still remain tax free. To determine your eligibility, divide the number of months you lived in the home by the 24 months required for the exemption. Multiply the quotient by your profit cap ($250,000 or $500,000) to reach your new profit cap limit. If your home sale profits fall below the new profit cap, you are eligible for the tax exemption.