Are you selling your home this summer? Be sure to read up on the tax consequences of a sale. Apart from focusing solely on how much profit you’ll gain or loss you will sustain as a result of the sale, you will need to understand whether the home you’re selling is your principal or secondary residence, and how the taxes differ for each of these situations.

What happens with a gain?

First things first—understand that a gain on a sale is not simply your profit from the sale. The gain is actually your home’s selling price, minus selling costs, deductible closing costs and your tax basis in the property.

You can exclude up to $250,000 of gain if you are selling your principal residence. $500,000 can be excluded if you are married filing jointly. You won’t have to worry about the 3.8% NIIT if you have a gain that qualifies for the exclusion, either. You can only claim the full exclusion if you have owned the residence and used the residence as your main home for two of the last five years before the sale date, and you have not claimed the exclusion for the sale of a primary residence within the previous two years.

What about a loss?

Losses on principal residence sales are not typically tax deductible, however if your home is rented out or used solely for your business, you may be permitted to deduct the loss attached to that portion.

Do the same rules apply for second homes?

The gain exclusion is not available to those selling second homes but if the home qualifies as a rental property, you can consider it a business asset and use an installment sale or a Section 1031 Exchange to defer tax on any gains.

What qualifies a home as “a primary residence”?

In order to be considered a primary residence, the home must:

• Be equipped with sleeping, cooking and plumbing facilities
• Be inhabited for the majority of the tax year.
• Be inhabited during at least 24 months out of the five years (months do not need to be consecutive) leading up to the date of sale. Note that there are certain exceptions to this—If you have a mental or physical disability, for instance, you only need to show that you’ve lived at the residence for 12 months. If you are a member (on qualified official extended duty) of Uniformed Services, Foreign Service, or if you are an employee of the intelligence community in the U.S., you can choose to suspend the five year test period for ownership.
• Be listed as your U.S. postal service address. This address also must be listed on your voter card, federal and state tax returns and driver’s license/car registration.
• Be near your work, bank, family members’ residences and recreational clubs and organizations.

Partial exclusions might be available

If you find that your home does not meet the above requirements, you may still qualify for the exclusion if you moved because of work, health problems or an unforeseeable event (death of spouse, casualty loss, natural disaster etc.). View Page 4 of the IRS’ Publication 523: Selling Your Home for a complete list.

Maintain your records!

It is vitally important for you to maintain thorough records. Be sure to hold on to:

• Information on your original cost
• Any subsequent improvements made to the property
• Any casualty losses that have reduced the home’s value
• Any depreciation claimed based on business conducted on the property

Selling your home and starting a new chapter in a new location can be a very exciting time. Make sure you know how the sale will affect your finances, though—and make sure you retain accurate records.

Questions on this? Feel free to contact us.