When selling a personal residence, taxpayers who have owned and used the home as their main personal residence for two out of the last five years can be eligible for an exclusion of up to $250,000 ($500,000 if filing married filing joint) of the gain recognized on the sale of their home. The gain is calculated by figuring the price received for the sale of the home less the cost basis. Cost basis includes what you paid for the residence, capital improvements and closing costs.
To meet the requirements of this exclusion, the taxpayer needs to qualify for two tests:
- Use test: the home needs to have been used as the main personal residence for 2 out of the past 5 years. Short temporary absences such as a brief period of vacation are considered for the purpose of this test.
- Ownership test: the home needs to be owned by the taxpayer for 2 out of the past 5 years
The two years do not have to be sequential and one does not need to meet both requirements at the same time.
There are certain exceptions for not meeting the two tests above and still be eligible for a prorated exclusion. These exceptions include special conditions such as a change in health, employment and unforeseen circumstances.
Homes that have had a period of nonqualified use are eligible for a portion of the exclusion. The ratio to determine the rate of the exclusion is:
the period of non qualified use/total period of ownership
Non qualified use is defined as a period after 2009 in which the home was not used as a personal residence. In addition, if the home was rented out, the depreciation which was allowed to be deducted as an expense against the rental income, is required to be recaptured and is not eligible for the exclusion. Please note that this is applicable whether or not the depreciation was expensed. The determining factor is the allowable depreciation.
There is no limit to the amount of time this exclusion can be used, but there does need to be at least a two years between sales.