The IRS allows an exclusion from capital gains tax for taxpayers who sell their primary residences. The exemption is allowed up to a certain amount of gain, based on the filing status of the taxpayer(s). To claim the exclusion, you must report the transaction on IRS Schedule D and attach the form to your 1040 income tax return. The amount of sale proceeds you must claim is reported to you on Form 1099-S. The title company that processed the sale must mail the form to you by the end of January.
The amount you may exclude from capital gains tax on the sale is $250,000 when your filing status is single, head of household or married filing separately. If your filing status is married filing jointly, you may exclude $500,000 from your capital gains. To determine your potential gain, subtract the sales price from your purchase price. If the result is negative, you have a loss on the sale and do not owe capital gains tax. If the result is positive, apply the exclusion amount. If your sales proceeds exceed the exclusion amount, you must pay capital gains tax on the difference.
Time in Home
To qualify for the exemption, you must have lived in the home as your primary residence for at least two of the last five years before the sale. To meet this test, the years do not have to be consecutive. For example, you may live in the house for one year, rent the house for the next three and live in the house again during the last year of the five year test. You may be exempt from meeting this test if you sold for specific reasons that were beyond your control. Examples of these circumstances include health, death, divorce or natural disaster occurrences. You may also be eligible if the sale is due to job relocation and your new job is at least 50 miles away from your old job.
If you own more than one home that you sold during the year, you may only claim the exemption for one sale. You must meet certain tests to determine primary residency rules in tax years where multiple sales are reported. In addition to the time in home rule, you may have to establish residency by providing additional information to the IRS, if requested. Examples of items the IRS may ask for include a driver's license showing your address, the address of your job, bank account locations and copies of regular expense statements that show your billing address.
Unmarried Joint Owners
If you own the home with someone who is not your spouse, each owner is eligible to claim the $250,000 exclusion when all other tests are met. This scenario may occur when any two unmarried people co-own the home and use it as their primary residence, such as a boyfriend and girlfriend, parent and child or domestic partnership couple.