When you sell your home, the capital gains on the sale are EXEMPT from capital gains tax. This is part of the Taxpayer Relief Act of 1997. If you are single, you will pay no capital gains tax on the first $250,000 you make when you sell your home, and married couples get to enjoy a $500,000 exemption. Before the law was introduced, homeowners could only qualify for a once-in-a-lifetime tax exemption of up to $125,000 on a home sale or roll those earnings into the purchase of another home. Today the rules aren’t quite so stringent:
- The home must be considered a primary residence. You must have occupied the residence for at least two of the last five years. This rule does, however, allow you to convert a rental property into a primary residence because the two-year residency requirement does NOT need to be fulfilled in consecutive years. For example, suppose that you invest in a new condo. You live in it for the first year, rent the home for the next three years and, when the tenants move out, you move back in for another year. At the end of this five-year period, you will be able to sell your condo without having to pay capital gains tax.
- You can only benefit from this exemption once every two years. Therefore, if you have two homes and lived in both for at least two of the last five years, you won’t be able to sell both tax free.
Another important thing to note: Capital gains tax on real estate isn’t necessarily an all-or-nothing proposition. If you’re nearing the cap on exemptions, you could still qualify for a partial exemption — just be sure to consult a tax professional before you make any big moves.
Do I have to report the home sale on my return?
You generally need to report the sale of your home on your tax return if you received a Form 1099-S or if you do not meet the requirements for excluding the gain on the sale of your home.
Form 1099-S: Proceeds from Real Estate Transactions is generally issued by the real estate closing agent—a title company, real estate broker or mortgage company.
To avoid getting this form (and having a copy sent to the IRS), you must give the agent some assurances at any time before February 15 of the year after the sale that all the profit on the sale is tax-free. To do so, you must assure the agent that:
- You owned and used the residence as your principal residence for periods totaling at least two years during the five-year period ending on the date of the sale of the residence.
- You have not sold or exchanged another principal residence during the two-year period ending on the date of the sale or exchange of the residence.
- No portion of the residence was used for business or rental purposes by you or your spouse.
- At least one of the following three statements applies:
- The sale price is $250,000 or less
- You are married, the sale price is $500,000 or less, and the gain on the sale is $250,000 or less
- You are married, the sale price is $500,000 or less, and:
- You intend to file a joint return for the year of the sale or exchange.
- Your spouse also used the residence as his or her principal residence for periods totaling two years or more during the five years ending on the date of the sale.
- Your spouse also has not sold or exchanged another principal residence during the two-year period ending on the date of the sale or exchange of the residence.
Essentially, the IRS does not require the real estate agent who closes the deal to use Form 1099-S to report a home sale amounting to $250,000 or less ($500,000 or less for married couples filing jointly).
You should not receive a Form 1099-S from the real estate closing agent if you made these assurances. If you don’t receive the form, you don’t need to report your home sale at all on your income tax return.
If you did receive a Form 1099-S, that means the IRS got a copy as well. That doesn’t necessarily mean you owe tax on the sale, though. It could be a mistake, or the closing agent might not have had the proper paperwork. If you qualify for the exclusion to make all of your profit tax-free, don’t report the home sale. But make sure all your paperwork is in order to show the IRS if it asks.