You are looking to sell your home but may make a big profit on it and you are wondering if you need to pay taxes on that gain. This is a question that pops up all the time in our Free Facebook Group and Tax Minimization Program that we want to tackle.

Fortunately the IRS has something call the "home sale gain exclusion" which allows you to potentially pay zero taxes on the gain from a personal residence. However, there are some thing you need to know to qualify which we will be discussing here.

What Is The Home Sale Gain Exclusion?

If you qualify, you can exclude gains up to a certain amount on the sale of your personal residence. The gains you can exclude are:

• Single: Exclude Up to $250,000 of Gains
• Married: Exclude Up to $500,000 of Gains

In order to qualify you need to pass two separate tests, the ownership test and the use test.

• Ownership Test: Must have owned the home for at least 2 of the last 5 years.
• Use Test: Must have used the home as your principal residence for at least 2 of the last 5 years.

If you have a gain larger than the exclusion then you would need to report that as a taxable gain. This would be done on Schedule D of your Form 1040.

Note: If you do not meet the tests above but are forced to sell due to a change in place of employment, health reasons or other unforeseen circumstances you may still be eligible for a prorated gain exclusion.

How Does The Home Sale Gain Exclusion Work If It Had Business Use?

If you used a portion of your home for your business, your business portion of the home would still qualify for the exclusion. However, if your office was not located inside your actual home but rather an unattached building on the property (example: garage, shed, etc), you need to allocate the gain between your living portion vs your office.

To help avoid this, if you know you are planning to sell within the next 2 years you can simply move your office into the home 2 years prior to the sale.

One important thing to note is that if at any point you claimed depreciation on your business for your home office (regardless of whether it was attached or unattached to your home) you would need to report unrecaptured Section 1250 gain on that depreciation portion.

Sale of Home Examples

Lets go through some examples to bring this all home.

• Purchased a house for $200k and live in it for year 3 and 4 and sell in year 5 for $400k.
  •  You would qualify for the home sale exclusion because you met both the ownership and use test.
• Purchased a house for $200k and live in it for a year and half and sell it for $300k.
  • You would NOT qualify for the home sale exclusion because you did not meet the 2 out of 5 year tests. Note you may qualify if you have a special circumstance (job change, health, etc). You would have a reportable gain of $100k.
• Purchased a house for $200k and lived in it year 1-4 and sold in year 4 for $400k but you had a home office inside the house. You did not take depreciation on your business for the home office.
  • You would qualify for the home sale exclusion on the full amount since you met the ownership and use tests, the office was inside the home, and you did not take depreciation on the business side.
• Same example as above but you took depreciation of $5,000 per year for the 4 years.
  • You would qualify for the home sale exclusion on the full amount since you met the ownership and use tests and the office was inside the home. However you would need to report $20,000 in unrecaptured Section 1250 gain.

Ultimately the home sale exclusion is a great gift from the IRS to avoid taxes on the sale of your principal residence. With that being said you do want to make sure you have everything setup correctly to ensure you qualify.

One last thing, if you plan to convert your home to a rental property you may want to look into selling your home to your S Corp and then using it as a rental. This can get complex and doesn't make sense in every situation but we talk about it in our Tax Minimization Program if you are looking for more information on that.

Bottom line, if you are selling your home make sure you are talking with your advisor or asking in our Tax Minimization Program to ensure you can take advantage of this. 

Do not be like a good client of ours that came into tax season and told us about a home they sold (without coming to us first) after only owning it for 19 months!