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When You Sell: How to Avoid Up to $250,000 or More of Gain

More of Gain If there will be gain on the sale of your home, your tax planning should focus with laser-like intensity on making sure the gain will qualify for exclusion from tax. This requires comparing the facts of your housing situation with the requirements for the exclusion discussed below, principally the two-year ownership and use requirements and the once-in-two-years rule. If you are married and want to qualify for the larger exclusion of up to $500,000, you also should check the special qualification rules for spouses, also discussed below.

What's This Exclusion of Up To $250,000 Or More Of Gain?

If you are single or if you are married and filing a separate return, you can exclude up to $250,000 of gain on the sale of your principal residence. If you are married and file jointly with your spouse, you can exclude up to $500,000. Provided you meet the eligibility rules discussed later, the exclusion is allowed each time you sell your principal residence.

Okay, How Do You Qualify for The Exclusion?

The exclusion is applicable to the sale of your home if two requirements are met.

First: Two Year Ownership and Use Requirement. During the five-year period ending when you sell your home, you must have owned and used it as your principal residence for periods aggregating two years or more.

Second: Two Year Waiting Period Requirement. You must not have used the exclusion within the preceding two years. The exclusion won't apply to your sale if, during the two-year period ending on the date of the sale, you made another sale to which the exclusion rules applied.

That's all there is to it!

If you meet these eligibility requirements, you can use the exclusion each time you sell your principal residence.

Condos and Co-ops. The exclusion is available to owners of condos and co-op apartments to the same extent it applies to owners of single family houses.

For co-ops, the ownership requirement applies to the stock that tenant-stockholders own in their cooperative housing corporations rather than to a house or condo, and the use requirement applies to their apartment in the co-op.

Home Office Exception. One of the most aggravating things about the tax law is its endless exceptions. Here's one for the exclusion: the amount of the exclusion may be reduced if you use a portion of your residence as a home office or for other commercial purposes. The exclusion is reduced by the dollar amount of depreciation allowed for rental or business use of the residence for periods after May 6, 1997.

Two Year Rule: Job Change or Health Problems

Suppose you can't meet the two-year ownership and use requirements or the two-year waiting period because of a job change or because of health problems. You still may be able to get the benefit of the exclusion if you qualify for special "hardship relief."

Kind-Hearted Uncle Sam. If you fail to meet either the two-year ownership and use requirement or the two-year waiting period requirement because of a change in place of employment, for health reasons or for certain other unforeseen circumstances to be specified in future regulations, you can exclude a fraction of the $250,000 (or $500,000) otherwise allowable. The amount excludable is equal to the portion or fraction of two years you meet the requirements.

Example. Suppose you are single and have owned and occupied your principal residence for 18 months. You get a great job offer in another state that you decide to take. You sell your house and move to the new job location, realizing a $50,000 gain on the sale. Since you met 75 percent of the two-year ownership and occupancy requirements (18 / 24), you are entitled to exclude up to $187,500 of gain (75% x $250,000). Thus, your full gain of $50,000 is excludable.

Physically or Mentally Infirm. Hardship relief also may be available for the physically or mentally infirm. The two-year use requirement is reduced for individuals who require out-of-residence care as a result of being physically or mentally incapable of caring for themselves. In such cases, where the individual owns the residence and uses it as a principal residence during the five-year period prior to sale for at least one year, the time the individual is in a licensed nursing home or other licensed facility is counted as time the residence is used as the individual's principal residence.

If You're Married: Bigger Break With Special Rules

Matrimony has tax virtues: while single individuals can exclude up to $250,000 of gain, married couples are eligible for a higher ceiling, up to $500,000 of gain.

But being married is not the only requirement for eligibility. There are four other requirements.

  1. You must file a joint return for the year in which the sale occurs.
  2. Either you or your spouse must meet the two-year ownership requirement.
  3. Both you and your spouse must meet the two-year use requirement.
  4. Neither you nor your spouse may have used the exclusion within the preceding two years.

If only one spouse meets these requirements and you and your spouse file a joint return, the exclusion is still available, but the $250,000 ceiling is applicable. Also, if you and your spouse file separate returns, the $250,000 ceiling is applicable.

Planning Tip: Death or Divorce of Spouse. If you are divorced from your spouse or your spouse has died, special rules may make it easier for you to qualify. To prevent hardship in these cases, so-called "tacking" of holding periods is permitted. This means you can add your holding period for the home to the holding period of your former spouse for purposes of figuring the two-year holding period.

Thus, for an unmarried individual whose former spouse is deceased on the date of sale, the period the deceased spouse held the property can be added to the surviving spouse's holding period to figure the two-year holding period. Likewise, where an individual acquires a principal residence incident to a divorce, the period the former spouse owned the property can be added to the divorced individual's ownership period to figure the two-year holding period.

Suppose a Spouse Moves Out? Good tax news: a separated individual owning a residence who has moved out of the residence is nevertheless treated as using the residence as a principal residence while such individual's spouse or former spouse is granted actual use of the residence under a divorce or separation agreement. This rule can help a spouse owning the residence who leaves the residence meet the two-year use requirement.

Spouses' Waiting Period. As explained previously, there is a waiting period: the exclusion generally applies to only one sale during any two-year period. Thus, the $500,000 exclusion is unavailable if, during the two-year period ending on the date of the sale, there was another sale by you or your spouse that qualified for the exclusion.

But this limitation of the exclusion to one sale every two years does not prevent a husband and wife filing a joint return from each excluding up to $250,000 of gain from the sale of each spouse's separate principal residence, provided the spouses would be permitted to exclude up to $250,000 of gain if they filed separate returns. In other words, the fact that your spouse doesn't meet the two-year waiting period doesn't disqualify you from using the exclusion (up to $250,000), if you otherwise qualify.

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