Introduction

Taxation can be very much of a concern when selling your home. Individuals try every possible way to sell their property at determined prices. 

One should not forget that while selling there will also be part of taxation to keep in mind. Calculating the amount of taxes you have to pay when selling your house is important.

If you are thinking of selling your house or want to know the taxation aspect before quoting a price, you must read this article. 

In this article, we will cover how you can save your profit by paying minimum taxes. Keep reading to know more.

The Capital Gains Tax: What You Need to Know 

The IRS offers a helpful provision called the principal residence exclusion. This provision reduces or eliminates capital gains taxes when you sell your primary residence. Its purpose is to give homeowners tax relief by taking a portion of their profits away from taxation.

The amount you can keep depends on how well you filed your taxes. If you file as a single person, you can keep up to $250,000 of your earnings, and married couples filing jointly can keep up to $500,000 of their profit. It’s important to know that this rule only applies to gains made from selling a primary home. Taxpayers must meet certain requirements, such as ownership and use tests.

This exclusion is a good way to get the most out of the sale of a home and make the best investment decisions.

121 Home Sale Exclusion

• Principal Residence: Full Exclusion Criteria

To qualify for the main home exclusion, you indeed need to satisfy both the ownership and use tests. To meet the ownership case requirements, for at least 24 months at any time in the preceding 5 years before the sale of the property, one must possess the property being sold. 

The IRS refers to this date as the selling date. If you are married and file your taxes together, only one spouse’s name is permissible on the title for the second case of ownership test to be fulfilled.

• Principal Residence: Partial Exclusion

If you don’t pass the ownership and use tests completely but you have a good reason for not meeting the two-year requirement, you can get a partial exemption. 

Which is in proportion to how long the individual was at home. The IRS considers reasons like being transferred for health reasons, work requirements, or other reasons that couldn’t be expected to be valid. If you were in your home for one year in the last five years, you only met half of the use requirement. 

This means you can only use 50% of the gains that are estimated at $125,000 for individuals or $250,000 for married couples filing jointly.

Remember that capital gains tax may be affected by certain factors, such as any depreciation claimed for the home. Also, consider any state or local taxes that may apply to the sale of your home.

Some exceptions to exclusion

• Until 1997, those over 55 didn’t have to pay capital gains taxes on their homes or other properties. In 2024-2025, there won’t be any exceptions for these adults, but there are some other exceptions to the two-out-of-five-year ownership and use rules.
• Official Extended Duty: If anyone or both spouses are on official long-term duty in the Foreign Service, the intelligence community, or in the military, then that couple selling a home may choose to defer their five-year test ownership and use period for up to ten years. A can member qualifies for “official extended duty” if they are working more than 50 miles away from their main home or residing in government housing on official orders for at least 90 days.
• Disability: If you become physically or mentally incapable of managing your affairs, you are likely to qualify for the full principal residence exemption. A licensed care facility can count towards the two-out-of-the-last-five-year use requirement if you spend time there.
• Death or divorce: Occasionally, you may learn privileged rules about ownership and use of a property when an owner dies or when a couple divorces. To meet the two out of five years of use rule, a widow or widower could add the years during which the spouse lived there. To meet the ownership rule, divorced individuals may be able to claim some years that their ex-spouse owned, but they must meet the use rule on their own.

Special Situations

• Widowed taxpayers

Widowed taxpayers might be able to raise the exclusion amount to $500,000 from $250,000 if all these conditions are met:

• They sell their house within two years following the death of their spouse.
• They are not remarried at the time of the sale.
• Neither the seller nor his deceased wife exercised the exclusion on another residence they sold that was less than two years old when they sold this one. They fulfill the two-year ownership and residency prerequisites. 

• Divorce

In the event of a divorce, a spouse granted ownership of a home may consider the years during which the property was owned by the former partner to meet use requirements. 

Moreover, if a grantee has an ownership interest in the house, the use requirement may cover the period when the former spouse is residing in the residence up until the time of its sale.

• Military 

Military personnel and other government officials. Military and government personnel deployed on official extended duty, along with their spouses, can elect to defer the five-year period for up to 10 years during their duty. 

In other words, so long as the military member spends two of every 15 years in the dwelling, they are entitled to the capital gains exclusion. 

Other Ways to Minimize Taxes

If you cannot meet the rules for the principal residence exclusion and do not qualify for any of the main exceptions, you might still be able to avoid paying capital gains tax when you sell your property.

• 1031 Exchange

1031 exchange allows the swapping of one property with another similar property. This allows delaying the related capital gains tax on the profits of the sale. This is only viable with the sale of investment property and is extremely intricate. 

One should, therefore, consult a tax professional or 1031 exchange company for guidance on eligibility and proper procedural follow-up.

• Tax Loss Harvesting

You may apply tax loss harvesting to cut the gains from selling your house. Just bear in mind that slashing the sale of your investment to lower the tax on capital gains is likely not the best idea, because then that investment, for which you received less than the amount it would eventually rise in value, actually takes more from you than the taxes you saved.

• Calculate your basis properly 

You only pay capital gains tax on the gain from selling your house. This gain is the sale price minus what you paid for the property. 

Again, the cost basis is accurately determined. This includes the price paid for a home plus all the buying and selling costs associated with it, such as realtor commissions and title fees, as well as significant property improvements taking more than a year to complete.

Conclusion

The principal residence exclusion is essentially an immediate ‘loophole’ that allows you to make a sale without paying any capital gains tax, provided that you have dwelled in the house for at least 24 of the preceding 60 months. 

However, to ease the complexities found in the rules created by the IRS you may contact Munshi Capital  to determine what is best for your situation.