29.1 Avoiding Tax on Sale of Principal Residence
If you sell (or exchange) your principal residence at a gain (29.5), up to $250,000 of the gain may be excluded from income if you owned and occupied it as a principal residence for an aggregate of at least two years in the five-year period ending on the date of sale and did not claim an exclusion on another sale within the prior two years. See the discussion of the two-out-of-five-year ownership and use tests in the following section (29.2). If you are married filing jointly, you may be able to exclude up to $500,000 of gain (29.3). Even if you do not meet the two-out-of-five-year ownership and use tests, you are entitled to a reduced maximum exclusion limit if the primary reason for your sale was a change in the place of employment, health reasons, or unforeseen circumstances (29.4).
Filing Instruction
Caution: If you use a residence as a vacation home or rental property after 2008, an allocable part of your gain may not qualify for the exclusion, even if you meet the two-out-of-five-year ownership and use tests (29.2).
Frequency of exclusion.
If you meet the ownership and use tests for a principal residence (29.2), you may claim the exclusion when you sell it although you previously claimed the exclusion for another residence, provided that the sales are more than two years apart. If you claim the exclusion on a sale and within two years of the first sale you sell another principal residence, an exclusion may not be claimed on the second sale even if you meet the ownership and use tests for that residence. There is an exception if the second sale was due to a change in employment, health reasons, or unforeseen circumstances. In that case, a prorated exclusion limit is allowed (29.4).
Planning Reminder
Principal residence.
A principal residence is not restricted to one-family houses but includes a mobile home, trailer, houseboat, and condominium apartment used as a principal residence. An investment in a retirement community does not qualify as a principal residence unless you receive equity in the property. In the case of a tenant-stockholder of a cooperative housing corporation, the residence ownership requirement applies to the ownership of the stock and the use requirement applies to the house or apartment that the stockholder occupies (29.2).
If you have multiple homes.
If you have more than one home, you may exclude gain only on the sale of your principal residence and only if you meet the ownership and use tests (29.2) for that residence. Your “principal residence” is determined on a year-to-year basis, based primarily on where you live most of the time. However, the IRS may also consider such factors as the primary residence of your family members, your place of employment, mailing address, the address listed on your tax returns, driver’s license and automobile and voter registration, and the location of your bank.
Vacant land.
Vacant land owned and used as part of a taxpayer’s principal residence may qualify for the exclusion. The vacant land must be adjacent to the residence and the sale of the residence must be within two years before or after the sale of the land. Qualifying sales of land and residence are treated as one sale, so the $250,000 exclusion limit ($500,000 for qualifying joint filers) applies to the combined sales. If the sales occur in different years, the exclusion limit applies first to the residence sale.
Business or rental use.
If part of your home was rented out or used for business, see the rules for determining whether you can exclude all or some of the gain on a sale (29.7). Also see the rules for deducting a loss where your residence was converted to rental property (29.9).
Home destroyed or condemned.
If your home is destroyed or condemned, any gain realized on the conversion may qualify for the exclusion. Any part of the gain that may not be excluded (because it exceeds the limit) may be postponed under the rules explained in 18.19.
Sale of remainder interest.
You may choose to exclude gain from the sale of a remainder interest in your home. If you do, you may not choose to exclude gain from your sale of any other interest in the home that you sell separately. Also, you may not exclude gain from the sale of a remainder interest to a related party. Related parties include your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendents (children, grandchildren, etc.). Related parties also include certain corporations, partnerships, trusts, and exempt organizations.
Expatriates.
You may not claim the exclusion if Section 877(a)(1) of the Internal Revenue Code applies to you. That section applies to U.S. citizens who have renounced their citizenship (and long-term residents who have ended their residency) if one of their principal purposes was to avoid U.S. taxes.
The exclusion is not mandatory.
You do not have to apply the exclusion to a particular qualifying sale. For example, you are unable to sell a residence when you acquire a new residence. When you finally are able to find a buyer for the first home, you also decide to sell the second residence. Assume both sales may qualify for the exclusion, but the potential gain on the first house will be less than the potential gain on the sale of the second home. You will not want to apply the exclusion to the sale of the first home if doing so will prevent you from applying the exclusion to the second sale because of the rule allowing an exclusion for only one sale every two years.
Federal subsidy recapture.
If your home was financed with the proceeds of a tax-exempt bond or a qualified mortgage credit certificate (15.1) and you sell or dispose of the home within nine years of the financing, you may have to recapture the federal subsidy received. Use Form 8828 to figure the amount of the recapture tax, which is reported on Form 1040 as a separate tax.