What is Primary Residence Exclusion
You may qualify to exclude from your income ALL or PART of any gain from the sale of your main. You may be able to exclude up to $250,000, $500,000 if married, from taxes if you meet the Primary Residence Exclusion requirements!
If you sell your main home, or primary residence, up to $250,000 may be excluded from your income. The amount jumps up to $500,000 for married couples that sell their primary residence.
Primary Residence Exclusion Requirements
To qualify you must meet the following requirements:
- 1. You owned the residence for any two of the last five years.
- 2. You occupied your residence for any two of the last five years.
- 3. You haven’t used the exclusion within the last two years.
If you are married you need to meet the following requirements:
- 1. You are married and file a joint return for the year.
- 2. Either you or your spouse have owned the residence for at least two out of the last five years.
- 3. Both you and your spouse have used the home as your principal residence for two out of the last five years.
- 4. Neither you nor your spouse have used the exclusion within the last two years.
Period of Ownership and Use
The required 2 years of ownership and use during the 5-year period on the date of the sale do not have to be continuous. You meet the IRS tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 x 2) during the 5-year period ending on the date of the sale.
Primary residence exclusion example 1: Home owned and occupied for 3 years – Kim bought and moved into her main home in September 2011. She sold the home at a gain on November 12, 2014. During the 3 year 2 month period ending on the date of the sale (September 16, 2011- November 12, 2014), she owned and lived in the home for more than 3 years. Kim meets the ownership and use tests above.
Primary residence exclusion example 2: Met ownership test but not use test – Carlos bought a home in 2009. After living in it for 6 months, he moved out. He never lived in the home again and sold it at a gain on May 15, 2014. He owned the home during the entire 5 year period ending on the date of the sale (May 16, 2009- May 15, 2014). However, he did not live in it for the required 2 years. Carlos meets the ownership test but not the use test. He cannot exclude any part of his gain on the sale, unless he qualified for a reduced maximum exclusion (explained later).
A loss on the sale of your principal residence is not deductible. If part of your principal residence was used for business in the year of the sale, you will need to treat the sale as if two pieces of property were sold. A loss is deductible only on the business part.
Frequency of Electing the Exclusion
You may NOT use the primary residence exclusion more than once every two years. If you claim the exclusion on a sale within two years of the first sale you sell another principal residence, an exclusion cannot be claimed on the second sale even if you meet the ownership and use tests for that residence.
There is an exception if the second sale was due to a change in employment, health reasons, or unforeseen circumstances. In that case, a prorated exclusion limit is allowed.
Exception to Primary Residence Exclusion
Some of the gain on a sale after 2008 might not be excludable, even if the two-out-of-five year ownership and use tests are met, if your use the residence after 2008 as a second home or rental property.
If you own more than one home, you can exclude the gain from the sale of your main home ONLY. You must include in income gain from the sale of any other home.
Note that the two years in the requirements doesn’t have to be consecutive.
Primary residence exclusion example 3:
- Year 1: Dan and Tanya Winton live in a small house.
- Year 2: They purchase the home.
- Year 3: They decide to move out and rent the house to Jamal through year 5.
Dan and Tanya can claim the exclusion up to $500,000 because they have owned the home two out of five years (years 2, 3, and 4) and have used it as their personal residence for two out of the last 5 years (years 1 and 2).
Primary residence exclusion example 4: Christine and Jerry were married a year ago. Prior to the marriage they both owned their own home. After they got married, they decided to live in Jerry’s home. Christine sold her home and used the primary residence exclusion to shield herself from taxes on the gain of the sale of her house. Now, Christine and Jerry have decided that they need a bigger house. They decide to sell Jerry’s house. The estimated gain on Jerry’s house is $430,000; they plan to use the married couples primary residence exclusion of $500,000 to shield them from taxes on the gain.
Christine and Jerry do not qualify for the full married couples exclusion because Christine doesn’t meet the ownership and use tests above. Jerry meets both tests and can file a separate tax
return and claim his exemption. This would shield only $250,000 of the $430,000 gain. The best options available to Jerry and Christine are:
- 1. Wait one more year so they both qualify and can use the married couple $500,000 exemption.
- 2. Sell now using Jerry’s $250,000 exemption and pay taxes on the other $180,000 of gain.
Exceptions to Primary Residence Exclusion Requirements
There are exceptions to the primary residence exclusion requirements. You can still claim an exclusion, but the maximum amount of gain you can exclude will be reduced if either of the following is true:
- 1. Change in employment – you may qualify for the exception if you change jobs. The new place of employment must be at least 50 miles farther from your home than the former place of employment was. This is known as the “50 mile safe harbor rule”.
Primary residence exclusion example 5: If you live in California and take a job in New York, obviously, you will qualify for the exclusion.
Primary residence exclusion example 6: You currently live 10 miles from your job. You take another job that is 45 miles away and decide to purchase a new house to be close to that job. You are not
eligible for the exclusion because your new place of employment is only 35 miles farther from your house to your former place of employment.
You may still qualify for the exception via the “facts and circumstances” test. For example, if you have a job that requires you to work unscheduled hours in which you have to arrive at work quickly, you may qualify for the exclusion.
- 2. Health problem – you can qualify for the exception if the sale of your main home is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual.
Qualified individuals include: parents, grandparents, stepparents, children, grandchildren, stepchildren, adopted children, brother, sister, stepbrother, stepsister, half brother, half sister, mother-in-law, father-in-law, uncle, aunt, nice, nephew.
A “physician safe harbor” is established if a licensed physician recommends a change of residence for one or more of the above reasons.
Primary residence exclusion example 7: Kevin and Tressa purchase a house that they use as their personal residence. 1 year later they sell the house to move closer to Tressa’s father, Darrell, who has a chronic disease and is unable to take care of himself. Due to the “facts” and “circumstances” that the sale of their home was the health of a qualified individual, Kevin and Tressa are entitled to claim a reduced maximum exclusion.
If the sale merely benefits your general health and well being, you do not qualify for the exclusion.
Primary residence exclusion example 8: Scott purchases a house in Concord. Scott is completely healthy and disease free. On a routine checkup, Scott’s doctor informs him that he needs more exercise. Scott decides to sell his house and move to Hawaii so that he can increase his level of exercise by playing golf and surfing year round. Scott is not eligible for the exclusion because the sale of his primary residence is only beneficial to his “general health”.
- 3. Unforeseen Circumstances – The sale of your home is because of an event that you did not anticipate before purchasing and occupying your main home.
To qualify you must meet one of the following:
- – An involuntary conversion of your home. For example, the home was condemned.
- – The home was destroyed by a natural disaster (earthquake, fire, tornado) or man-made disaster (war, terrorism).
- – Death
- – Termination of employment making the individual eligible for unemployment compensation.
- – A change in employment or self-employment status that results in your inability to pay reasonable living expenses. These include food, clothing, medical expenses, taxes, transportation, court ordered payments, and expenses reasonably necessary to produce income.
- – Divorce or legal separation under a decree of divorce.
- – Multiple births resulting from the same pregnancy, such as twins.
Primary Residence Exclusion Maximum Dollar Limitation
Now just because you meet one of the exemptions doesn’t mean you get to exclude the entire $250,000/$500,000 amount. The exclusion amount is reduced and this reduction is based on a portion or fraction of the two years that you met the requirements. The numerator is classified as either days or months. The denominator of the fraction is 730 days or 24 months. This, of course, depends on how the numerator is specified.
Primary residence exclusion example 9: Nathan is single and owns and occupies his principal residence for 14 months. He gets another job 100 miles away and decides to relocate. He sells his house and moves closer to his new job, realizing a $65,000 gain on the sale of his home. The full amount is deductible because it is less than his reduced exclusion amount of $145,833[(14/24) x $250,000]. The $145,833 is the maximum amount he is eligible to exclude