Federal tax laws allow each individual taxpayer to exclude up to $250,000 of gain from the sale of his/her main home, if he/she meets certain ownership and occupancy requirements. (A married couple that meets the qualifications can exclude up to $500,000.) If an individual/couple is unable to exclude all or part of the gain, then the gain is taxable as a capital gain in the year of sale. Exclusion QualificationsUnless they meet the reduced exclusion qualifications, taxpayers must meet the ownership and use tests in order to qualify for exclusion of gain. This means that during the five-year period ending on the date of the sale, taxpayers must have: Owned the home for at least two years (if a joint return only one spouse need meet the ownership test), and Except for short temporary absences, lived in (used) the home as their main home for at least two years. The required two years of ownership and use during the five-year period ending on the date of the sale do not have to be continuous. Taxpayers meet the tests if they can show that they owned and lived in the property as their main home for either 24 full months or 730 days during the five-year period ending on the date of sale. Also see ownership-use exceptions elsewhere in this article. Temporary Absence: Generally, a temporary absence would be for illness, education, business, vacation, military service, etc., for less than one year, and the taxpayer intends to return to the home, and continues to maintain the home in anticipation of such return. Land: Generally, if a taxpayer sells the land on which his/her main home is located, but not the house itself, the taxpayer cannot exclude any gain from the sale of the land. However, the home sale exclusion will apply to vacant land sold or exchanged if the taxpayer owned or used the land as part of the principal residence, provided the disposition of the dwelling unit occurs within two years before or after the disposition of the vacant land, the land was adjacent to land containing the dwelling unit and the land sale or exchange otherwise satisfies the home gain exclusion requirements. Only one maximum exclusion amount applies to the combined sales/exchanges of both the home and the vacant land. Ownership and Use ExceptionsUse Test After Divorce – In divorce situations, the terms of the divorce or separation document often allow one spouse to use the jointly-owned home for an extended period of time, then to sell the home and split the proceeds with the former spouse. When this happens, the spouse who does not occupy the home will no longer meet the use test and would be barred from excluding the gain except for a special rule for divorced couples. Under this special exemption, that spouse is considered to have used the property as his or her main home during any period they owned it. Disability – Individuals who have become physically or mentally unable to care for themselves are considered to have used their home during any period that they own the home and live in a licensed facility, including a nursing home that cares for individuals with the taxpayer’s condition. However, to qualify for this exception, the individual must have owned and lived in his or her home for at least one year. This exception does not apply to the ownership test. Irrevocable Trust Is Owner – Some taxpayers use revocable (living) trusts as an alternative to having their property transferred by will. A home owned in the name of a revocable trust is treated as being owned by the taxpayer for purposes of the ownership test, and such ownership does not jeopardize the ownership test for claiming the exclusion. However, when the first spouse of a married couple with a revocable trust dies, two things generally occur. The decedent’s trust becomes irrevocable and the portion of the home inherited receives a new basis (an exception may apply for decedents dying in 2010). If all or part of the home is placed in the decedent’s (bypass) trust, the IRS has ruled that to the extent a home is owned by an irrevocable trust, it is not owned by the surviving spouse, even if the surviving spouse continues to reside in the home. As a result, the portion of the home owned by the irrevocable trust would not qualify for the exclusion. Death of Spouse Before Sale – If your spouse died before the date of sale and you do not meet the ownership and use tests yourself, you are considered to have owned and lived in the property as your main home during any period of time when your deceased spouse owned and lived in it as a main home. Home Transferred in Divorce – If the home was transferred to you by your spouse, or former spouse, incident to divorce, and you do not meet the ownership test, you are considered to have owned it during any period of time when your spouse, or former spouse, owned it. Home Destroyed or Condemned – If you were able to defer gain from a prior home to your current home because it was destroyed or condemned, you can add the time you owned and lived in that previous home when figuring the ownership and use tests for the current home. Maximum ExclusionA taxpayer who meets the ownership and occupancy tests can exclude the entire gain on the sale of his/her main home up to $250,000, provided gain has not been excluded on a sale of another home within two years of the sale of the current home. The maximum exclusion amount is $500,000 if all the following are true: a) The taxpayers are married and file a joint return for the year. b) Either the taxpayer or the taxpayer’s spouse meets the ownership test. c) Both the taxpayer and taxpayer’s spouse meet the use test. d) During the two-year period ending on the date of the sale, neither the taxpayer nor the taxpayer’s spouse excluded gain from the sale of another home. Two-Year Period Between SalesUnless taxpayers qualify for the reduced exclusion, they can only exercise the exclusion once every two years.Therefore, taxpayers cannot exclude the gain on the sale of their home, if during the two-year period ending on the date of the sale, they sold another home at a gain and excluded all or part of that gain. Home Acquired By Tax-Deffered ExchangeIf the home was originally acquired via a Sec 1031 tax-free exchange, the home must be owned for a minimum of five years before a home-sale gain exclusion can be utilized, provided the taxpayer also meets the 2-year use test. Reduced ExclusionA taxpayer who does not qualify for the full exclusion may still qualify to exclude a reduced amount if the taxpayer(s) did not meet the ownership and use tests, or the exclusion was disallowed because of the once every 2-years rule, but sold the home due to: a) A change in place of employment; b) Health; or c) Unforeseen circumstances, to the extent provided in IRS regulations. Amount of Reduced Exclusion – If qualified, the reduced exclusion is determined on an individual basis, and in the case of married taxpayers, the individually computed amounts are combined for the joint exclusion. To determine the reduced exclusion, multiply $250,000 (maximum exclusion amount) by a fraction whose denominator is 730 and numerator is the shorter of: (1) The number of days during the five-year period just prior to the current sale that the property was owned and used by the taxpayer as his/her principal residence; or (2) The number of days between the current sale and the immediately prior sale of a principal residence if the exclusion applied to the prior sale. More Than One HomeIf a taxpayer has more than one home, only the gain from the sale of the taxpayer’s main home can be excluded, even if the other home meets the two-out-of-five-year ownership and use test. Main Home: The property that the taxpayer uses the majority of the time during a year will ordinarily be considered the taxpayer’s main home or principal residence. A taxpayer’s main home can be a house, houseboat, mobile home, cooperative apartment, or condominium. Example: Figure #1 illustrates a situation where a taxpayer has two homes, both of which meet the ownership test. The taxpayer also meets the occupancy test, since the taxpayer has lived in both homes more than two years of the prior five-year period. However, only the New York home qualifies, since the taxpayer lived in the New York home the majority of the time in all five preceding years, thus qualifying it as the taxpayer’s main home. In addition to the taxpayer’s use of the property, the home sale regulations list relevant factors in determining a taxpayer’s principal residence which include, but are not limited to: the taxpayer’s place of employment; the principal place of abode of the taxpayer’s family members; the address listed on the taxpayer’s Federal and state tax returns, driver’s license, automobile registration and voter registration card; the taxpayer’s mailing address for bills and correspondence; the location of the taxpayer’s banks; and the location of religious organizations and recreational clubs with which the taxpayer is affiliated.