Any profit you make from the sale of your principal residence is considered a capital gain, and is subject to the capital gains tax. This tax has higher exemptions and lower rates of taxation than taxes on other forms of income.
The information in this article applies to homeowners who have lived in the house for at least 2 years during the 5-year period ending on the date of sale. The information also applies to the sale of vacant land adjacent to your principal residence, used as part of your principal residence, and sold within 2 years of the sale of the principal qualifying residence. However, it does not apply to those who have sold the land, but not the house itself.
Only the sale of your principal residence is eligible to be treated as a capital gain. You cannot claim the profits from the sale of a second house under the capital gains tax rules.
Calculating the amount of capital gain or loss
The amount of capital gain or loss from the sale of your home is calculated using selling price, less selling expenses, less the adjusted base price of your home. A positive number means you have realized a capital gain on the sale. A negative number means that you have realized a capital loss on the sale.
The selling price is the total amount of payment you receive for you house, regardless of the form of the payment. If part of the payment was made in property or services, the value of that property is calculated based on fair market value.
Selling expenses include all fees which you have paid in order to sell the house. Common selling expenses include legal fees, realtor commissions, and advertising fees. If the sale also includes having to pay loan charges, those also count as selling expenses.
The adjusted base price of your home is based on the price you paid for it, regardless of the form of payment. If you received the house as an inheritance or gift, the price is usually considered to be its fair market value.
Depending on the deal you made when you bought the house, you may also include closing costs, realtor commission, legal fees, survey fees, title fees, title insurance, costs of connecting or installing utilities, and some real estate taxes. If you are contracting to have your house built on land you own, your basis includes the cost of the land and costs of construction. This is not a comprehensive list of all allowable adjustments to determine the adjusted base price of your home. For more information, see the IRS page on basis of property.
Home business or rental income
If you have a home office or part of the qualifying principal residence was used for business purposes, or if you rented out part of your principal residence for income, treat the sale of the principal residence as two separate property sales: the first for the residential part of your property, the second for the business part of your property. How to divide the property selling price between residential and business is based on the percentage amount of the property you used for your business.
The business portion of any profit or loss after selling your house is calculated as part of the business tax return. Only the residential part is treated as a capital gain or loss.
Exceptions to the residential rule
Members of the military, intelligence service, Foreign Service, or Peace Corps can suspend the 5-year test period for residency during any time that they serve overseas. The 2-year residency requirement must still be met after the suspended 5-year test period is removed from consideration.
Individuals with a disability which has worsened to the point that they are no longer able to live independently only need to have lived in their primary residence for a single year. Time spent living in an assisted care home counts for as long as the principal residence has not been sold.
Destruction of the principal residence
If your house has been destroyed, the loss is treated as a capital gains loss. If you sell the now-vacant land within 2 years from the date of destruction, any profit from the sale of the land will be treated as a capital gain. For further information, see Publication 547.
Calculating the capital gains tax
If you and your spouse jointly owned the principal residence which has just been sold and you file a joint tax return, the capital gain or loss will be calculated on that return. If you and your spouse have joint ownership but file separate returns, your gain or loss is based on your ownership interest in the house, as determined by state law. Unmarried joint owners always calculate gain or loss based on ownership interest.
For the 2010 tax year, you can exclude up to $250,000 of the capital gain on your primary residence. For joint ownership with separately filed returns, each person who used the house as a principal residence for the required 2 years and has ownership interest in the house can exclude up to $250,000 of the capital gain. Only joint owners who meet the use test can claim the capital gains exclusion.
Any remaining capital gain on the sale of the house is considered a long-term capital gain and is taxed normally under the capital gain rules. As of 2010, long-term capital gains are subject to a 15% tax rate, or 5% tax rate for the lowest two tax brackets.
The capital gains tax for capital gains due to selling a house is calculated using Schedule D, Form 1040.