In many areas, residential real estate markets have surged, and some are still surging. In these sellers’ markets, big home-sale gains are likely. That’s great news if you’re a seller — but will you owe taxes on the profit?

If you sell your principal residence for a large profit, you can potentially exclude tax (pay no federal income tax) on a certain amount of profit. Here are the basics of how to take advantage of this tax-saving opportunity.

Gain Exclusion Qualification Rules

Single taxpayers can exclude home-sale gains up to $250,000, and married joint-filing couples can exclude up to $500,000. However, you must pass the following tests to be eligible:

1. Ownership test. You must have owned the property for at least two years during the five-year period ending on the sale date. Two years means periods aggregating 24 months or 730 days.

2. Use test. You must have used the property as your principal residence for at least two years during the same five-year period. (See “What Counts as a Principal Residence?” at right.)

Periods of ownership and use don’t need to overlap. For example, you could rent a home and use it as your principal residence for Years 1 and 2, and then buy it and rent it out to others for Years 3 and 4. If you then sell the property in Year 5, you’d pass both the ownership and use tests and qualify for the gain exclusion privilege.

Important: To qualify for the larger $500,000 joint-filer exclusion, at least one spouse must pass the ownership test and both spouses must pass the use test.

What Counts as a Principal Residence?

This can be a good question if you own and occupy several residences. The general rule says your principal residence for the year is the one where you spend the majority of time during that year. According to IRS regulations, other relevant factors can include:

•  Where you work,

•  The mailing address used for your bills and correspondence,

•  The address shown on your income tax returns, driver’s license, and auto and voter registration cards,

•  Where you maintain your bank accounts,

•  Where you maintain religious affiliations and club memberships, and

•  Where family members and pets live.

For example, Maria owns one home in Texas and another in Florida. From 2017 to 2021 (five years), she spends seven months each year in the Texas home and the remaining five months in the Florida home.

Maria sells both properties in January 2022. Barring unusual circumstances, the Texas home is considered her principal residence, and she can claim the gain exclusion privilege only for that property. That’s the case even though she spent about 25 months in the Florida home during the five-year period ending on the sale date (more than the requisite 24 months).

Can you pass the ownership and use tests for two residences at the same time? This is possible in certain situations. For example, Barry owns one home in Ohio and another in Nevada. During 2018 and 2019, he lived in the Ohio home. During 2020 and 2021, he lives in the Nevada home.

If Barry sells either home in 2022, he’d qualify for the gain exclusion privilege because he passes the ownership and use tests for both homes. However, if he sells both homes in 2022, he can’t claim gain exclusions for both sales. That’s prohibited by the anti-recycling rule explained in the main article.

Contact a Pro

For many homeowners these days, the federal home-sale gain exclusion deal is one of the most valuable personal income tax breaks on the books. But there are numerous rules and restrictions. We can help you cash in. As with any major financial transaction, you should consider the federal income tax consequences before closing on a home sale.

Hoberman & Lesser’s NYC accountants serve a broad cross section of businesses, ranging from publicly held companies, to private sector businesses, to individual entrepreneurs throughout New York, New Jersey, and Connecticut, and across the United States. To schedule a complimentary and confidential consultation with a member of our team, please contact us.