Exclusion of Gain From the Sale of a Personal Residence

A taxpayer may exclude up to $250,000 ($500,000 for a married couple filing jointly) of gain on the sale of a personal residence if the taxpayer owned and occupied the residence for at least two of the previous five years. If the taxpayer held the home less than two years, a prorated portion of the exclusion may apply. The number of times a homeowner may use this exclusion is unlimited, except that the exclusion can be used only once every two years. The law is advantageous to most families because it allows them to earn large profits on their residences tax free.

Example

The Wilsons bought their home in 1992 for $50,000. In 1992, they added a deck and pool for $25,000. They lived in the home until they sold it for $300,000 in March of this year. Selling costs were $20,000. They would calculate their taxes as follows:

The exclusion is available only once every two years, but there are several exceptions. Under the old rules, if the home has been held less than two years and if the move is job-related or health-related or there were other unforeseen circumstances, the taxpayer was allowed a prorated portion of the exclusion. The IRS ruled that unforeseen circumstances could include:

Divorce, legal separation, or death of a spouse
Becoming eligible for unemployment compensation
A change in employment that makes it impossible to pay the mortgage or basic living expenses
Multiple births resulting from the same pregnancy
Damage to the home from a natural disaster, act of war, or terrorism
Condemnation, seizure, or involuntary conversion of the property, such as foreclosure

Capital Gain Calculation
Selling price	$300,000
Less selling expenses	– $20,000
Equals amount realized	$280,000
Basis
Original cost	$50,000
Plus improvements	+ $25,000
Equals adjusted basis	$75,000
Gain on sale ($280,000 – $75,000)	$205,000
Less exclusion on sale of residence	– $500,000
Taxable capital gain	$0

Taxation of gain from sale of real estate

Capital gain Calculation Factors:

Short-term capital gains (for property held for one year or less) are taxed at the investor’s ordinary income tax rate. Long-term capital gains (property held for more than 12 months) are taxed at different rates, depending on the taxpayer’s income.

Capital gains income is subject to an additional 3.8% Medicare tax for single filers making more than $200,000 or married couples filing jointly who make more than $250,000.

When investment property is sold, the investor must pay 25% (recapture rate) of the amount that the taxpayer used for depreciation deductions.