Most sales of primary residences are tax-free

Q: Now that the Idaho real estate market has recovered a bit, we are considering selling our home and buying a bigger house for our growing family. One friend told me I don’t have to pay any tax on the sale of my current home, but another said I have to make sure I buy a more expensive house to avoid taxes. We most likely will end up in a more expensive house, but now I am confused about any taxes I might owe. Can you clear this up?

A: There was a time when any gain from selling a personal residence had to be “rolled into” the purchase price of the next home to avoid paying tax. To make this work, you normally had to purchase a more expensive home than the one you sold. Everyone also had the once-in-a-lifetime $125,000 exclusion on the gain from the sale of a personal residence. Although these rules were changed back when Bill Clinton was president, I still have clients who think this is current law. Not so!

Today the rules for reporting the sale of your personal residence are generally more favorable to taxpayers. Whether you purchase a more expensive home, a less expensive home or do not replace your home at all is no longer a factor. Much or all of any gain from the sale can be excluded from your income. The important factors today are how long you have used the home as your residence and the amount of the gain you recognize on the sale. For most taxpayers, the sale will not be taxable, but you may still have reporting requirements to avoid getting a “nastygram” from the IRS.

As long as you meet certain requirements, you can exclude up to $250,000 of gain from the sale of your home. A married couple filing a joint tax return can double that and exclude $500,000 of gain. The gain is determined as the difference between the selling price (normally the contractual sales price stated on the first line of the HUD-1 statement you receive at closing), less your original cost of the home, plus the cost of improvements you have made, plus all the expenses of purchasing and selling the home, such as brokers’ commissions and fees. Unless the home has appreciated significantly since the purchase, most residence sales are tax-free.

To qualify for the gain exclusion, you must determine if your home qualifies as your personal residence. Generally, you must have owned and used the property as your main home for at least two out of the five years before the date of sale. Brief absences from the home are allowed as long as the total use in the five-year period is at least 730 days (365 days in a year times two years). There are also exceptions to this two-year rule for certain military personnel and in cases where you are forced to sell due to a change of employment, health reasons or other unforeseen circumstances. Also, you can exclude a gain from the sale of only one main home per two-year period. Finally, if there was prior business use of the home and depreciation, see a tax professional; some gain reporting is likely required.

As additional good news, the excluded gain is not subject to the new Net Investment Income Tax enacted under the Affordable Care Act. If, however, you are unfortunate enough to lose money on the sale of your home, the loss is not tax deductible.

Assuming you can exclude all of the gain on the sale or your home, you probably won’t need to report the sale on your tax return. But if some of the gain is taxable, you will need to report it on Schedule D as a capital gain. And even if the sale does not result in a taxable gain, if you receive a Form 1099-S, Proceeds From Real Estate Transactions, be sure to report the sale (just show no gain or loss) so the IRS can match the 1099 to your return.

So now you can go back to your friends and explain the real story behind selling your house. But please be careful with other tax advice you may want to share. You never know when someone will write to me and challenge what you told them!

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To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation.

Peter Robbins is a partner in the Boise office of CliftonLarsonAllen LLP, specializing in tax matters for small businesses, individuals, and trusts and estates.

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