Will the Sale of Your Home Be Taxable?

According to the US Census Bureau, approximately 65% of American households own their homes, and for many families the home is their most valuable asset. The Federal Reserve estimates that Americans have accumulated $35 trillion in home equity, which is more than 400% of its 2012 value at the market bottom.

With so many people benefiting from near-record levels of home equity, it’s no wonder that many of our clients are curious about how those gains will be taxed.

How the Section 121 Home Sale Exclusion Works

As a general rule, gains on the sale of real estate are taxable, including gains on second homes and rental properties. However, there is a special exception under Section 121 of the tax code for the sale of your principal residence. It allows you to exclude up to $500,000 of gain on joint returns ($250,000 for most other filers) if you have owned and used the home as your principal residence for at least two of the five years before the sale. Even better, you can use this gain exclusion once every two years with no lifetime limit.

Example: What the Exclusion Can Save You

Let’s look at an example. Suppose a married couple bought their home for $300,000 and sold it for $800,000 after owning and living in it for at least two years. Without the exclusion, and ignoring any improvements or selling costs, the $500,000 gain could incur federal taxes of up to $119,000. However, if they meet the Section 121 requirements, the $500,000 gain would be entirely free of federal income tax. If their gain had been $550,000, then only the $50,000 excess over the $500,000 exclusion would be subject to tax.

Exceptions That Can Change the Answer

Unsurprisingly, the Section 121 gain exclusion has numerous complications and exceptions, including changes in marital status, death, prior rental or business use, and relief for unforeseen circumstances. Many (but not all) states conform to the federal exclusion.

When to Talk With a Tax Advisor

Fortunately, the experienced tax team at DBA is ready to analyze your particular circumstances whenever the time is right for you to make a move.