There's no itemized or above-the-line tax deduction available for expenses when you sell your house. However, the Internal Revenue Code (IRC) does offer an exclusion from capital gains tax when you sell your primary residence. If you meet specific income criteria, your profits won't be taxable.
Learn what home sale exclusions are, what you can deduct, and how to qualify.
How the Home Sale Exclusion Works
The Internal Revenue Service (IRS) allows unmarried homeowners to exclude up to $250,000 in profit from capital gains tax when they sell their residences. The exclusion amount increases to $500,000 for married taxpayers who file joint returns.
Homeowners must pass the residency, ownership, and look-back tests to qualify for the tax exclusion.
If you have a co-owner to whom you're not married—for example, you bought the property with a relative or a partner—you can each take an exclusion of up to $250,000.
The Residence Test
Both spouses—or a single taxpayer if they're not married—must have lived in the home for at least two of the last five years preceding the sale to qualify. This is referred to as the "residence test."
The two years don't have to be continuous—if you lived in a home for six months per year for four years, you'd still qualify. The only caveat for couples filing jointly is that they both need to meet the residency requirement individually.
For instance, if your husband didn't live in the home for 24 months, but you did, you wouldn't receive the full exclusion for a married couple filing jointly—you'd only be able to exclude $250,000.
The Ownership Test
You must also own the property for at least two of the five years ending on the date of sale. This is called the "ownership test," and the IRS figures that the home is your primary residence if you meet both this and the residence test. If you’re married and filing a joint return, only one of you must pass the ownership test.
You need to meet all three test requirements to claim the exclusion.
You don’t have to own the home and live in it simultaneously. You might have lived in the house as a tenant for a while before actually purchasing it, but you don't need to be living there when you sell it—you need only have owned it for two years.
The Look-Back Test
The look-back test determines eligibility based on previous home sales. If you sold a home during the last two years but didn't take an exclusion, or didn't sell a home within the last two years, you pass the look-back test and can claim the exclusion.
Other Qualifying Limits
You, your spouse, or another co-owner cannot have claimed an exclusion for a gain from the sale of another home within the two years immediately preceding this house sale.
And if you own more than one residence, you can only exclude a gain realized from the sale of your primary home, which is the one you live in more than any others during the tax year.
The IRS recognizes that some circumstances should be exempt from the usual qualifying tests. You might be exempt from one or more of these tests and limits if:
- Your spouse or co-owner died.
- You and your spouse separated or divorced.
- You sold a remainder interest in the property.
- Your previous home was condemned or destroyed.
- You owned a vacant lot next to your property, used it, and sold it within the last two years.
- You served in the U.S. military, Foreign Service, or intelligence community while you owned the home.
Servicemembers can suspend the usual five-year period for to up to 10 years when they're on qualified official extended duty at a station that's at least 50 miles from their homes, and they're living by order in government housing.
This list isn't inclusive. Check with a tax professional if you believe something unforeseen or catastrophic caused you to sell the home without qualifying according to the usual rules.
Calculating Your Capital Gain
It's essential to understand how to determine capital gains from your home's sale so you can deduct them correctly on your taxes. You'll need to know your basis and how to factor in any qualified improvements you may have made.
For example, you might have purchased your property for $250,000 and paid $7,000 in allowable closing costs. Your cost basis would then be $257,000 because you're allowed to include these costs in your basis.
You can also include the expense of some improvements you made to the property. Suppose you made $20,000 in structural, nondecorative enhancements to your home to ready it for sale. Your basis now increases to $277,000.
Suppose you were to end up selling your home for $300,000. You would have a capital gain of $23,000—$300,000 less the basis of $277,000.
Deductions Can Offset Your Gain
Adding expenses and the cost of capital improvements increases your cost basis, and a higher cost basis decreases your capital gain. You're more likely to fall within the exclusion limit if you have less of a profit, and you'll at least pay taxes on less profit if your entire gain isn't excluded.
Your gain would have been $50,000—$300,000 less the $250,000 you paid for the property—if you hadn't been able to add the cost of improvements and closing expenses to your basis.
Which Costs Qualify?
Most costs associated with a sale of a property can qualify as deductions from your gains. The "Adjusted Basis" section of IRS Publication 523 offers a complete list of possible adjustments you can make to your cost basis using these costs. Keep all of your receipts so you won't overlook anything.
You would not have to pay capital gains tax on that $23,000 gain—or even on $50,000—because both these figures fall well below the exclusion threshold. But the costs of improvements and closing can make a difference if your gain is close to the exclusion threshold.
How Are Capital Gains Taxed?
Any gain you realize over the exclusion amount is taxed as a long-term capital gain if you owned the house for more than one year. The tax rate on long-term capital gains depends on your taxable income. As of 2021, it works out like this:
- 0% on incomes up to $80,000
- 15% on incomes from $80,001 to $441,450
- 20% on incomes over $441,450
Married taxpayers filing joint returns:
- 0% on incomes up to $80,000
- 15% on incomes from $80,001 to $496,600
- 20% on incomes over $496,600
- 0% on incomes up to $80,000
- 15% on incomes from $80,001 to $469,050
- 20% on incomes over $469,051
Most taxpayers pay capital gains tax at less than 15%, so if you don't qualify for the exclusion, you might want to set aside 15% of any profits made from a home sale.
How To Report Taxable Gains
Should you elect not to claim the exclusion for some reason, or if you don't meet the various requirements, you should report any gain as income on IRS Schedule D and submit it with your Form 1040 tax return. Otherwise, there's no need to report the sale.
An exception exists if you have a capital loss rather than a gain, and you receive a Form 1099-S from the transaction. In that case, you might want to consult with a tax professional, because the IRS does not allow deductions for capital losses from selling your main home.
State Taxes: Another Possible Deduction
Check on the capital gains tax rate in your state as well. Any state taxes that you must pay on the sale of the house will not reduce your capital gain, but you can include these taxes as an itemized deduction on Schedule A, along with other state income taxes you paid.
The Tax Cuts and Jobs Act (TCJA) began limiting the state and local tax deductions to $10,000 in 2018.
The higher standard deductions that the TCJA introduced have caused many tax filers not to itemize their deductions. Itemizing generally causes a taxpayer to give up the higher standard deduction—sometimes resulting in higher taxes.
Frequently Asked Questions (FAQs)
How often can you use the home sale exclusion?
You can only use the home sale exclusion once every two years. Although you can sell multiple properties during that time, you can only claim the exclusion once.
How do you claim the home sale exclusion?
In most cases, you don't need to do anything to claim the home sale exclusion. You'll only need to report your sale if the full amount of the gain is not excludable, you don't wish to exclude all of it, or you received Form 1099-S for your sale. If any of these situations is the case, you'll report the sale and the excludable amount using Form 8949 and Schedule D of Form 1040 when you file your tax return.