When selling your primary residence, it is still important to consider taxes – and they can be complicated. As a capital asset, your home is subject to capital gains tax, and you may have to pay tax on the profit made from the appreciation of your home. Exceptions do exist, however.
Explanation of the 2-Out-of-5-Year Rule
For individuals, you may qualify to exclude up to $250,000 of your capital gain from your tax return if you sold your primary residence, and you may be able to exclude up to $500,000 if you filed jointly. It is necessary to meet both the ownership and use tests to qualify for that exclusion.
For the 2-out-of-five-year rule to apply, two years must have passed required for the 2-out-of-five-year rule to apply. However, you don’t have to live there when the sale occurs, and these two years don’t have to be consecutive. You can exclude this amount whenever you sell your home, but you can only do so every two years.Â
Under IRS guidelines, a primary residence can be lived in for a year, rented out for three years, and then moved back into for a year before selling.Â
In addition to the two-out-of-five-year rule, there are some exceptions.
It does not matter whether you rented out your home while on vacation or for a short period because you still lived there for that period. Regardless of whether you become incapable of taking care of yourself and need to stay in a facility for some time, that time still counts towards your 2-year residence requirement. The state or other political entity must license the facility for people with the same condition to be cared for in the facility.Â
It is possible to exclude a portion of your gain if you lived in your home for less than 24 months, but you must qualify due to a particular circumstance. The eligibility test has the following exceptions:
- Divorce or separation
- Spouse’s death
- There was a sale of vacant land
- You owned restriction rights, and you sold them
- There was a fire or condemnation at the previous residence
- When you owned the property, you served in the military
- The home was acquired or relinquished as part of a 1031 like-kind exchange
It is still possible to qualify for partial gain exclusion under the 1031 exchange 5-year rule without meeting the eligibility requirements.
- Moving for work
- Moving for health reasons
- In the course of a pregnancy, the death of a loved one can occur, a home can burn down, two or more children can be born at the same time, or one can become eligible for unemployment benefits.
Depending on your particular circumstance and the time spent living at the residence, you may be entitled to a partial claim.
Divide the number of months lived in the home by 24 to calculate the exclusion. In the case of a married couple, multiply that number by $250,000. Your taxable income can decrease by the amount of gain remaining.Â
To qualify for the 1031 exchange five-year rule, you must follow the 2-out-of-5-year rule when selling your home.