Maybe you're one of the lucky ones that actually still has some equity in their home. Maybe you're even luckier that you found somebody to buy your home in the middle of our housing crisis. Now the question remains is how much tax you'll have to pay on the sale. What, tax on a home sale? Well, that depends. Currently, the IRS allows for an exclusion of up to $250,000 for an individual filer and $500,000 for a couple filing married, filing joint, — to any taxpayer who satisfies certain tests known as the Ownership Test and the Use Test.
Do You Pass The Test?
Don't worry. This isn't a test that requires a No. 2 pencil and a Scantron. The tests are just certain guidelines that you have to pass.
- The Owner Test. The home must have been owned and use as a principle residence for at least two to five years proceeding the day of sell. Note — these years do not have to be consecutive. They only have to add up to at least two years.
- Use Test. Either spouse can meet the ownership test, but both must meet the use two-out-of-five-year test. This is likely not difficult for most married couples, but it can be burdensome for individuals who are divorced or in the process of a divorce.
If the taxpayer fails to meet either test because of a change in appointment or health, the taxpayer may be entitled to a partial exclusion based on the shorter of the taxpayer's use or ownership.
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Example: Mary and Ben, both mid-life individuals, get married, and Ben moves into the house that Mary has been using as her principle residence for seven years. Nine months later, Ben gets a job promotion, and the newlyweds move to a new city. They realize a gain of $700,000 on their sale. Mary has met both the ownership and use test, but Ben has not. Therefore, Mary gets the full exclusion of $250,000 of taxable gain; however, because Ben has been in the house for only nine months, he's eligible for an exclusion of only 93,750, which is 9/24 or 0.3750 times $250,000. Their total exclusion is $343,750, and they must pay tax on the remaining gain of 356,250 at capital gains rates.
The above is a perfect example of a situation where you may assume that you'll qualify for the full exclusion. You need to check the facts and make sure you pass the two tests.
Relief For Widows
Previously, the full $500,000 exclusion could be claimed by a surviving spouse only if the home was sold in the year that a joint return was filed, which generally is limited to the year when the spouse dies. But starting in 2008, a surviving spouse may exclude up to $500,000 of profit from the sale of the principal residence if the sale occurs within two years of the spouse’s death.
Have more questions? Go to real estate tips section of IRS.gov.