You won’t pay tax on the sale of your home unless you have gains that are more than $250,000 if you’re single, or more than $500,000 if you’re married and file jointly. The IRS provides a home sales exclusion that allows taxpayers to realize some significant gains on the sale of their primary residences, subject to several qualifying rules.
What Is the Home Sales Exclusion?
You used to get a one-time option of excluding up to $125,000 in capital gains on the sale of your home, as long as it was your primary residence and you’d reached the age of 55. That changed with the Taxpayer Relief Act of 1997.
The TRA provides that anyone, regardless of their age, can exclude up to $250,000 of gains on the sale of a home—and a married couple filing jointly can exclude up to $500,000. That means most people will pay no tax on the sale of their home unless they have lived there for less than two out of the last five years.
Who Qualifies for Tax-free Gains When They Sell Their Home?
You must meet the following IRS requirements to qualify for the capital gain tax exclusion on your home sale:
- The ownership test: You owned the home for at least two of the last five years.
- The residency test: You lived in the home as your main residence for at least two of the last five years.
The home must be your primary residence, not a secondary or vacation home.
These rules specifically prohibit you from claiming the home sales exclusion more than once in any two-year period.
Your ownership period and residency period don’t have to be concurrent. You could rent the home and live there for two years, then purchase it and own it for the remaining three years while living elsewhere. You can use this capital gain exclusion to avoid tax on a home sale over and over provided that you meet these rules.
How Are Gains or Losses Calculated?
You can calculate the capital gain on your home by taking the original purchase price and subtracting any applicable selling costs, less the cost basis. Your cost basis is what you paid for the home plus the cost of any qualifying home improvements.
For example, you might have paid $175,000 for the property and you spent $20,000 on allowable improvements and additions. Your cost basis would be $195,000. You later sell the home for $250,000 less commissions and fees of $5,000, leaving you with $245,000. The difference between the $245,000 and the $195,000 is your capital gain: $50,000
You won’t pay tax on this gain if you lived in the home for at least two years, owned it for at least two years, and didn’t exclude the gain from another sale in the last two years. That $50,000 falls well under the exclusion threshold whether you’re married or single.
You don’t get to take the loss as a tax deduction if you sell your home for less than what you paid for it.
If You Haven't Owned and Lived in the Home Long Enough
If you owned the home for one year or less, any gain over the excludable amount is taxed at a rate that will be the same as your ordinary income tax rate. This would be a short-term capital gain. For example, you would pay a 24% rate if your uppermost dollar of income reached this tax bracket.
Long-term capital gains tax rates would apply if you owned the home for longer than a year, and these are much kinder than ordinary income tax brackets. They depend on the amount of your overall income. As of the 2020 tax year—the return you’d file in 2021—they are:
- 0%: Up to $40,000 if you’re single, up to $80,000 if you’re married and filing jointly, or up to $53,600 if you qualify to file as a head of household
- 15%: From $40,001 to $441,450 if you’re single, $80,001 to $496,600 if you’re married and filing jointly, or from $53,601 to $469,050 if you qualify as head of household
- 20%: Over these upper amounts for each filing status
You’ll also owe capital gains tax if you meet all these rules but you realize gains of more than $250,000, or $500,000 if you're married and filing jointly. Keep receipts and records of any improvements you made to the home to help reduce the total amount of your taxable gains. Certain types of home improvements can be added to your cost basis, and will reduce the amount of reported gain.