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Capital Gains Tax Exemption on Your Primary Residence

**Please be sure to talk with your tax professional and legal advisor regarding real estate related taxes involved in selling your property.

Your home is probably the most valuable asset you own. It is also probably
your best tax shelter. Selling a home can be a major event in the lives of its owner.

Thanks to the Taxpayer Relief Act of 1997, selling a home does not have to be a major tax event.

Exclusion on the Sale of a Main Home.

According to the Taxpayer Relief Act enacted in 1997, married couples receive up to $500,000 in capital gains tax exclusion for the sale of a principal residence where the owner has resided in the property for two of the last five years. Single owners enjoy similar $250,000 exclusion. The “two years” in question do not need to be consecutive years. In the five years prior to the sale of the house, you need to have lived in the house for at least 24 months in the 5-year period. Any profits in excess of the exclusion caps ($500,000 for married couples; $250,000 for singles) will be taxed at the new lower capital gains tax rate. Best of all, this principal residence exclusion can be reused each time you sell your main home. Keep in mind, the home must have been your principal residence. Generally, you can claim the exclusion only once every two years. (Some exceptions do apply)

Reporting Gain In Excess of the Exclusion Amount on the Sale of Your Home

The gain in excess of the allowable exclusion is reported on Schedule D as a capital gain. If you owned your home for one year or less, the gain is reported as a short-term capital gain. If you owned your home for more than one year, the gain is reported as a long term capital gain.

Exceptions to the 2 out of 5 Year Rule.

If you lived in your home less than 24 months, you still may be able to exclude a portion of the gain. Exceptions are allowed if you sold your house because a required job change, because of health concerns, or for some other unforeseen circumstances that you couldn’t reasonably have anticipated before buying and occupying your main home.
Your CPA can help you here.

The “Gain” from the Sale of Your Home

To calculate the gain from the sale of your home, use the following procedure:

  1. Take the selling price of the home minus the expenses from the sale of the
  2. From this number, then subtract the basis of the home – which is the price that
    you originally paid for the home plus any improvements.
  3. The net selling price minus the basis equals the gain on your home!
    It’s a bit more complicated than this, so don’t try it at home! This final figure is the
    realized gain from the sale of the home.

Losses on the Sale of a Residence

Taxpayers still cannot deduct losses on the sale of their residence.

The Sale of More than One Home in Two Years

You can’t exclude a gain on the sale of your home if, during the two-year period ending
on the date of the sale, you sold another home at a gain and excluded all or part of that
gain. If you can’t exclude the gain, you must include it in your income.

For more information, please refer to the link for the Internal Revenue Service
Publication 523 –

Sources: Internal Revenue Service Publication 523; IRS Tax Tip 2006-54; California
Society of CPAs; Financial Planning Taxes and Selling Your home
compiled by Scott Reeves 01/17/06


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