Selling Your Home and the Capital Gains Tax

Today's tax question comes from T. Dennis in California. He asks:

"I read your pieces on capital gains and home sales and the IRS publications. I just want to make sure I'm interpreting it correctly.

I clearly meet the ownership/use tests as I have lived in the townhouse I own for more than the last 5 years. I'm getting married this year and looking to sell the home before the end of the year. If I read the information correctly, my new spouse (who has lived in the house since January '06) does not meet the use test and if we sell it this year we will be limited to a maximum exemption of $250K rather than the $500K for married folks.

Have I got it right? Thanks!"

Mr. Dennis,

You got it! You must own and live in your house for two years in order to claim the full $250,000 capital gain exclusion on the sale of your main home. Married couples can exclude $500,000 in capital gains.

Here's how the IRS explains the maximum exclusion for married couples, quoted from Publication 523:

You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true.

• You are married and file a joint return for the year.
• Either you or your spouse meets the ownership test.
• Both you and your spouse meet the use test.
• During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another home.

If either spouse does not satisfy all these requirements, the maximum exclusion that can be claimed by the couple is the total of the maximum exclusions that each spouse would qualify for if not married and the amounts were figured separately. For this purpose, each spouse is treated as owning the property during the period that either spouse owned the property.

You clearly meet the ownership and use test since you have both lived and owned your townhouse for five years. However, your fiance does not meet the use test (lived in the house at least two years). So you cannot claim the higher $500,000 exclusion. You might want to calculate the taxable amount of your gain. I provide a formula for calculating your gain and taxable portion in my article: Selling Your Home. Remember to include your selling costs and major improvements as part of your cost basis.

Once you run the numbers, you'll be in a good position to figure out if now is a good time to sell, or perhaps you can wait another year or so to meet the ownership and use tests for the full $500,000 exclusion.

More information:

• Selling Your Home: Capital Gains Taxes
• Capital Gains Essentials

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