Making Cents: Taxation on the sale of your residence
By: John P. Napolitano, CFP®, CPA, PFS, MST
As we all know, just about anything that you sell for a gain comes with a tax bill. There are a few exceptions, with your primary residence being one of them. The home sale exclusion allows a married couple to exclude up to $500,000 of gain on the sale of their primary residence. The exclusion would be $250,000 for a single taxpayer.
In order to qualify as your primary residence, the home in question must have been occupied by you for at least 2 of the past 5 years. This seems pretty cut and dry, but it gets more complicated if you’ve claimed a deduction for a home office, get married or divorced, own the home with someone other than a spouse or had rented it previously.
If you are taking a home office deduction for expenses in your home you must depreciate the home also. Depreciation that you took or could have taken will reduce your basis and be subject to a 25% tax when you eventually sell that home, even if the sale is years after the home office ceased to exist. This is significant. Many tell me that they haven’t taken the depreciation deduction. Too bad, your basis gets reduced for depreciation allowed or allowable.
A similar tax treatment will occur if you have a rental property that is later converted to your primary residence. Any depreciation taken while the property was a rental will be re-captured and taxed at 25%.
If a single person sells a home this year, that exclusion would be $250,000. But, if that person had a live in partner for two of the past 5 years, and then gets married before 12/31 of the same year of the sale, the couple would them exclude $500,000 of the gain. This double tax break could be a huge planning opportunity for a young person who bought in a major metro area where real estate has appreciated significantly.
In divorce, you can still get the $500,000 exclusion as long as one of the spouses owns the home, both meet the 2 out of 5 years use test and neither has sold another primary residence within the past 2 years.
The most liberal interpretation of the home sale exclusion is when the home is owned and occupied by more than one person or couple. If the home is owned by two single people who both live and use the home, then each owner would qualify for the $250,000 exclusion. But if one of the owners was married, and the spouse also met the 2 out of five year’s residency requirement, then that couple can qualify for a $500,000 exclusion. That makes the total excludable gain from the sale of that home $750,000.
For those who live in their own multi family dwelling, your accounting for the gain is the same as it was for reporting income and expenses from the rental property. If you live in half, and rent half then 50% of the gain will qualify for the home sale exclusion.
John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. US Wealth Management, US Financial Advisors and LPL Financial do not offer tax advice. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.