It might not matter at all. In fact, there's a good chance you won't even have to report the sale to the IRS because most home-sale profit is now tax free.

• Do I have to pay taxes on the profit I made selling my home?
• How do I qualify for this tax break?
• How do I qualify for a partial exclusion?
• Deciding whether to take the exclusion
• Do I have to report the home sale on my return?
• Figuring the gain on the sale of a home
• What is the original cost of my home?
• What is the adjusted basis of my home?
• How to treat postponed gains under the old "rollover" rules?

Do I Have to Pay Taxes on the Profit I Made Selling My Home?

It depends on how long you owned and lived in the home before the sale and how much profit you made. If you owned and lived in the place for two of the five years before the sale, then up to $250,000 of profit is tax-free. If you're married and file a joint return, up to $500,000 of the profit is tax-free if you meet the ownership and residency test. The law lets you "exclude" this much otherwise taxable profit from your taxable income. (If you sold for a loss, though, you cannot take a deduction for the loss.)

You can use this exclusion every time you sell a primary home, as long as you owned and lived in it for two of the five years leading up to the sale haven't sold another home in the last two years.

If your profit exceeds the $250,000/$500,000 limit, the excess is reported as a capital gain on Schedule D.

How Do I Qualify for This Tax Break?

There are three tests you must meet in order to treat the gain from the sale of your main home as tax free:

There are three tests you must meet in order to treat the gain from the sale of your main home as tax free:

1. Ownership: You must have owned the home for at least two years (730 days or 24 full months) during the five years prior to the date of your sale. It doesn't have to be continuous nor does it have to be the two years immediately preceding the sale. If you lived in a house for a decade, then rented it out for two years prior to the sale, for example, you would qualify under this test.
2. Use: You must have used the home you are selling as your principal residence for at least two of the five years prior to the date of sale.
3. Timing: You have not excluded the gain on the sale of another home within two years prior to this sale.

Also, if you're married:

• You must file a joint return.
• At least one spouse must meet the ownership requirement, and both you and your spouse must have lived in the house for two of the five years leading up to the sale.

Special Circumstances

Even if you don't meet all these requirements, there are special rules that may allow you to claim either the full exclusion or a partial exclusion.

• If you acquire ownership of a home as part of a divorce settlement, you can count the time the place was owned by your former spouse as time you owned the home for purposes of passing the two-out-of-five-years test.
• To meet the use requirement, you are allowed to count short temporary absences as time lived in the home even if you rented the home to others during these absences. If you or your spouse is granted use of a home incident to a divorce or separation agreement, the spouse who doesn't live in the home can still count the days of use that the other spouse lives in that home. This can come into play if one spouse moves out of the house but continues to own part or all of it until it is sold.
• If either spouse dies and the surviving spouse has not remarried prior to the date the home is sold, the surviving spouse can count the period the deceased spouse owned and used the property towards the ownership and use test.

Members of the Uniformed Services or Foreign Service

You can choose to have the five-year test period for ownership and use suspended during any period you or your spouse serve on "qualified official extended duty" as a member of the uniformed services or Foreign Service. This means that you may be able to meet the two-year use test even if, because of your service, you did not actually live in your home for at least the required two years during the five-years prior to the sale.

How to Qualify for a Partial Exclusion?

In certain cases, you can treat part of your profit as tax free even if you don't pass the two-out-of-five-years tests. A partial exclusion is available if you sell your house before passing those tests because of a change of employment or a change of health or because of other unforeseen circumstances such as a divorce or multiple births from a single pregnancy. So, if you need to move to a bigger place to house the triplets, the law won't hold it against you.

Note this: A partial exclusion does NOT mean you can exclude only part of your profit. It means you get less than a full-fledged $250,000/$500,000 exclusion. So, for example, if a married couple owned and lived in their home for must one year before selling it, they could exclude up to $250,000 of profit (one half of the $500,000 because they owned and lived in the home for just one-half of the two year requirement).

Deciding Whether to Take the Exclusion

Would it ever make sense to turn down the government's generosity and not claim the exclusion?

Although very unlikely, paying tax on a home sale can make sense if it preserves the exclusion to protect more profit on another home that you plan to sell within two years. Remember, although you can use the exclusion any number of times during your life, you can't use it more than once ever two years.

Do I Have to Report the Home Sale on My Return?

You generally do not need to report your home sale on your income tax return, as long as you did not receive a Form 1099-S, Proceeds from Real Estate Transactions, from the real estate closing agent (that is, a title company, real estate broker, or mortgage company).

To avoid getting this form, you must give the agent some assurances at any time before January 31 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:

1. 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.
2. 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.
3. No portion of the residence was used for business or rental purposes by you or your spouse.
4. At least one of the following three statements applies:
   • The sales price is $250,000 or less, or
   • You are married, the sales price is $500,000 or less, and the gain on the sale is $250,000 or less, or
   • You are married, the sales price is $500,000 or less, and:
     1. You intend to file a joint return for the year of the sale or exchange,
     2. 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, and
     3. 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 do not 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.

Figuring the Gain on the Sale of a Home

You have a gain if you sell your house for more than it cost. Ah, but how do you calculate the real cost? For tax purposes, you need to pinpoint your adjusted basis to figure out whether or not you have gained or lost, in the sale.

The adjusted basis is essentially what you've invested in the home; the original cost plus the cost of capital improvements you've made. Capital improvements add value to your home, prolong its life, or give it a new or different use. They don't include expenses for routine maintenance and minor repairs. Examples of improvements are a new roof, a remodeled kitchen, a swimming pool, or central air conditioning. You add these expenses to your original cost to increase your adjusted basis (which in turn decreases the amount of gain on a sale).

On the other hand, you need to subtract any depreciation, casualty losses, or energy credits that you have claimed to reduce your tax bill while you've owned the house. Also, if you postponed paying taxes on the gains made from selling a previous home (as was allowed prior to 1997 for homeowners who used the profits to buy a replacement house), then you must also subtract that gain from your adjusted basis. Let's say you bought a house for $50,000 in 1993, sold it in for $75,000 in 1996 and postponed the tax on the $25,000 profit by purchasing a new home for $110,000. The basis of the new home would be $85,000 (the $110,000 cost minus the $25,000 on non-taxed profit on the first sale).

What Is the Original Cost of My Home?

The original cost of your home, for most people, is the amount you paid for your home.

If you purchased your home from someone else, the price you paid is your purchase price (plus certain settlement and closing costs). Your closing statement should list all of these costs. Don't include items from your closing statement that are personal and routine expenses, such as insurance or homeowner association dues, and don't include those costs that were pro-rated taxes and interest.

If you built your home, your original cost is the cost of your land plus the amount it cost you to construct your home, including amounts paid to your contractor and subcontractors, your architect fees, if any, and connection charges you paid to your utility providers.

If you inherited your home, your basis in the home will be the number you use for "original cost." Your basis is the fair market value of your home on the date of the previous owner's death, or an alternate date if the executor of the estate from which you inherited the home elected to use an alternate date. The executor of the estate should have provided you some information about the basis of your home.

What Is the Adjusted Basis of My Home?

The Adjusted Basis is simply the cost of your home adjusted for tax purposes by improvements you've made or deductions you've taken.

For example, if the original cost of the home was $100,000 and you added a $5,000 patio, your adjusted basis becomes $105,000. If you then took an $8,000 casualty loss deduction, your adjusted basis becomes $97,000.

Here's how you calculate the adjusted basis on a home:

1. Start with
   • The purchase price of your home (as described above), or
   • If you filed Form 2119 when you originally acquired your old home to postpone gain on the sale of a previous home (back in 1997 or earlier), use the adjusted basis of the new home calculated on your Form 2119. For more information, see How to Treat Postponed Gains Under the Old Rules.
2. To that starting basis, add:
   • The cost of any improvements that added value to your home, prolonged its useful life, or gave it a new or different use
   • Any special tax assessments you paid
   • Amounts spent after a casualty (disaster such as a hurricane or tornado) to restore damaged property
3. From that upwardly adjusted basis, subtract:
   • Certain settlement fees or closing costs
   • Depreciation allowed for any business use portion of your home
   • Residential energy credits claimed for capital improvements
   • Payments received for easements or right-of-ways
   • Insurance reimbursements for casualty losses
   • Casualty losses (from accidents and natural disasters) that you deducted on your tax return
   • Adoption credits or nontaxable adoption assistance payments for improvements added to the basis of your home
   • First-time homebuyers credit
   • Energy conservation subsidies excluded from your gross income

The result of all this calculating is the adjusted basis that you will subtract from the selling price to determine your gain or loss. This adjusted basis is what's considered to be your cost of the home for tax purposes.

Basis When You Inherit the Home

If you inherited your home from your spouse and you lived in a community property state—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin—your basis will generally be the fair market value of the home at the time of your spouse's death.

If you lived somewhere other than a community property state, your basis for the inherited portion of the home will be the fair market value at your spouse's death multiplied by the percentage of the home your spouse owned. If your spouse owned the home by him or herself, for example, the entire basis would be "stepped up" to date-of-death value. If you and your spouse jointly owned the home, then half of the basis would rise to date-of-death value. Let's say you and your spouse own a home jointly with an adjusted basis of $100,000. When your spouse dies, the house is wroth $200,000. Your basis becomes $150,000—your original half of the basis ($50,000) plus date-of-death-value of your spouse's share of the home ($100,000).

If you inherited your home from someone other than your spouse, your basis will generally be the fair market value of the home at the time the previous owner died.

Divorce and the Basis

If you received your home from your former spouse or ex-spouse as part of a divorce after July 18, 1984, your tax basis generally will be the same as your basis as a couple at the time of the divorce. So, if your former spouse was the sole owner of the home, his or her basis becomes your basis. If the place was jointly owned, you now claim the full basis.

If you divorced before July 19, 1984, your basis will generally be the fair market value at the time you received it.

Postponed Gains under the Old "Rollover" Rules

In the past, you may have put off paying the tax on a gain from the sale of a home, usually because you used the proceeds from the sale to buy another home. Under the old rules, this was referred to as "rolling over" gain from one home to the next. This postponed gain will affect your adjusted basis if you're selling that new home. The tax on that original sale wasn't eliminated, just deferred to some future time.

You can no longer postpone gain on the sale of your personal residence. For sales after May 6, 1997, you normally must choose whether to exclude the gain on the sale of your personal residence or to report the gain as taxable income in the year it is sold. You no longer have the option to postpone paying taxes on the gain.

To see how a rollover of gain prior to the change in the law can affect your profit, consider this example: Let's say you bought a house for $50,000 in 1993, sold it in for $75,000 in 1996 and postponed the tax on the $25,000 profit by purchasing a new home for $110,000. The basis of the new home would be $85,000 (the $110,000 cost minus the $25,000 on non-taxed profit on the first sale).

For More Information

For information on the basis for figuring out whether you have a gain or loss on the sale of your home, see IRS Tax Topic 703: Basis of Assets. For general information on the sale of your home, see IRS Publication 523: Selling Your Home, and Tax Topic 701: Sale of Home.