One of the major dilemmas that both married and unmarried home owners face is what happens to the $250/500k capital gains tax exclusion if you sell your home after owning it or living in it for less than two years?
In these situations above you may be denied the $250k/$500k exclusion and have to pay tax on your home sale profits. If you have owned the home for less than a year you may even have to end up paying tax at your top income tax rate (up to 35%), instead of at the 15% long-term capital gains rate.
However there is hope, because you may qualify for a partial exclusion. You may not receive the full $250k/$500k but you could get something very close, and it could still be enough to safeguard you from paying any tax.
For example, those who purchased homes less than two years ago (and therefore do not qualify for the maximum exclusion) probably won’t yet have $250,000 or $500,000 worth of capital gains that could be taxed. That includes many luxury homeowners as well.
Example
Ben and Jennifer purchased a $1 million house one year ago. Since then it has risen in value by 20%. The couple only need $200,000 out of their $500,000 maximum exclusion to protect them from paying tax. Owners of smaller homes, or homes that have risen in value by less, require an even smaller ‘piece’ of the maximum exclusion.
You may be asking yourself ‘How do I qualify for a partial exclusion?’ Partial exclusion is only available if the primary reason for your home sale is one of the following:
1. A change in work location
2. Health problems
3. ‘Unforeseen circumstances’
As the IRS can never be 100% certain why you sold your home, they have introduced a number of ‘safe harbors’. These are easy to apply tests which help you determine whether your home sale qualifies for tax-free treatment if you sell for work or health reasons or because of unforeseen circumstances.
If your home sale doesn’t qualify under one of the safe harbors you may still qualify for a reduced exclusion if the evidence shows that your home sale was primarily due to a change in your work location, for health reasons or due to unforeseen circumstances. For example:
· Did the change in your work location happen while you owned and used the property as your home? If you lived somewhere else you’ll struggle to claim the exclusion.
· Did you sell your home to help diagnose or treat a disease, illness or injury or to provide medical or personal care? If so you may qualify.
· Did you suffer a natural or man-made disaster causing you to sell your home?
To conclude, you must be prepared to defend your position if you have an audit. If the IRS thinks that, based on the facts and circumstances, you don’t qualify you will have to pay back taxes, interest and penalties.
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