How to Minimize Tax on the Sale of Your Primary Residence.

There are many reasons for people to sell primary homes during their lifetime.  People move to different locations due to work-related move. People may also have to sell their home, upgrade to a bigger home when the family has more members or downgrade the home when kids go to college, out of the home.  Deciding to sell the homes which is not easy for many people due to the tax the tax they have to pay for selling the home. Therefore, to minimize tax on the sale of primary residence is the ultimate goal for home seller to achieve.

Most people may hear about IRC §121 exclusion which the taxpayer can exclude the gain up to $250,000 or $500,000 for married filing jointly from the gross income.  In the past 15 years, house price has increased at a rapid pace. Many people have a large equity in their home and they hesitate to sell/downgrade to a smaller home because of the tax on the gain they have to pay.  We can go to the details how to take the full exclusion of $500,000 gain. Better than that, a taxpayer can even take more than $500,000 gain exclusion if he/she has proper planning before selling the primary house.

This post won’t go to the details of the primary residence definition during a tax year. In general, for individuals who own more than one home, the primary residence is where they spend most of their time. There is only one primary residence during a given year.

To take advantages of IRC §121 exclusion for second and rental homes, please refer to How to Reduce Capital Gain Tax on The Sale of The Second and Rental Homes

 Primary requirements 

To minimize tax on the sale of a primary residence, a taxpayer needs to satisfy three main requirements

 1.  Ownership

If the tax payer owns the home for at least 24 months out of the last 5 years to the closing date, the taxpayer meets the ownership requirement. For a married couple filling jointly, one one spouse has to meet the ownership requirement 

 2.  Residence  

  This requirement is similar to the ownership requirement which the taxpayer resides in the home as the primary home for at least 24 months out of the last 5 years to the closing date.  However, there are few differences:

• 24 months (730 days) of residence does not have to be consecutive, as long as the taxpayer resides in the home as his/her primary resident for 730 days within the last 5-year period
• Each spouse must meet residence requirement for a married couple filling jointly . Temporarily away from home like a short vacation still meets residence requirement

If the taxpayer becomes physically or mentally unable to care for himself/herself, and he primary home has been used for 12 months in the last 5 years, time for staying in a licensed care facility still counts toward the residence requirement. 

3.   Look-back Period

• The taxpayer can only take this tax advantage once every 2 years.  So if the taxpayer sold any primary home and take the exclusion during the 2-year period before the closing date, the taxpayer doesn’t qualify for the gain exclusion

If a taxpayer meets the ownership, residence, and look-back period and taking exceptions into account (discussed later), the home sale qualifies for the maximum exclusion of the gain ($250,000 for single taxpayer and $500,000 for a married couple filing jointly)
If the taxpayer doesn’t meet one of these 3 requirements nor exceptions to these requirements (to be discussed below),  the taxpayer is most likely to pay tax on the whole gain whether it’s a long term or short term capital gains unless the home is qualified for a partial exclusion of the gain.

Exceptions to primary requirements

    I will have a different blog post on these exceptions to the requirements and how to plan to take the advantage of the exceptions of the exclusion. 

• Divorced or separated:         
• Become widower
• Vacant land sale
• Home destroyed or condemned
• Service, Intelligence, and Peace Corps personnel.
• Remainder interest
• The home was acquired in like-kind/1031 exchange

Partial exclusion of gains

If a taxpayer doesn’t qualify for the full gain exclusion, the partial exclusion is only available if the taxpayer can prove that there are unforeseeable events causing the sale arose during the time the taxpayer owned and used your property as your residence.  Some examples of the events:

• Work-related move
• Health-related move:  the move to obtain medical care for yourself or for family members 

Author’s Recommendations

• Taxpayers can take the advantage of the $250,000 or $500,000 exclusion by purchasing a home and make it primary residence once every 2 years to get tax free (up to $500,000) on the gain given with the assumption that the housing market price keeps going up

• Widower and divorced taxpayer are in the exception category; hence they can also plan to take the advantage of this exclusion.   Will be discussed in a different blog post

• It appears that the maximum for full gain exclusion is $500,000 for a married filling couple.  However, there’s a way to exclude more than $500,000 gain to minimize tax on the sale of the primary residence. That is if there are 2 or more home-owners who own the home. To simplify, each home owner is married and file joint return, the gain exclusion can be a maximum of $1,000,000 rather than $500,000.

                For example:  A and B are co-owners of their primary resident home.  The home was purchased in 2010 for $500,000.  A got married in 2015 and B got married in 2017; both A and B have married jointly tax filling status .  A, A’s spouse and B, B’s spouse have lived in the home until it’s sold in 2020 for $1.5 Millions.  In this case, A and B can exclude all $1 Million gain and pay no tax on the home gain.  How does it work?

              By the end of the tax year of the home sold, both A and B will receive  a 1099-S  from the title company.  A and B should request the 1099-S if they don’t receive this tax form.  The 1099-S will show the sold price ($750,000 for A and $750,000 for B, assume that A and B have 50% ownership).  The basis of the home which is $500,000 will be split into $250,000 for A and $250,000 for B.  Since A his/her spouse and B and his/her spouse are married couples and meet the both residence and ownership requirements, A and B would get the maximum of $500,000 gain exclusion.