It has often been said that there are two certainties in the world: death and taxes. However, with the sale of your principal residence, most of the time a seller can avoid paying tax on the proceeds received!  So, you have decided to sell your house and are concerned with paying income tax on the proceeds?  Are you about to attend your closing and this thought just popped into your head? Did you just deposit your proceeds check and now are scared the IRS will be coming for your bank account?

Simply put, the IRS requires individuals to pay capital gains tax on “gain” or money made in a transaction. This means that you will be taxed on the difference between what you paid for real estate and the sales price.  So, if you paid $100,000 for a house and sold it for $150,000 you have “gain” in the amount of $50,000.  Therefore, this $50,000 would be subject to tax.  However, the IRS has a law that states that if you sell your principal residence for a gain and you have had the house for at least two years, you can exclude up to $250,000 in gain from tax.  If you are married, the level is $500,000 in gain.  So, a couple selling their qualifying principal residence can take up to a half a million in profit without having to pay a single penny in tax!

With this advantageous tax rule, several people have attempted to use this rule for property that is not necessarily a principal residence. So, what is a principal residence?  Several tests are used to determine whether your house is a principal residence and subject to this tax free sale allowance.  Some of the factors used are: Where are you registered to vote?  Where do you receive your mail? What school district do your kids attend? What address is on your driver’s license? What address is on your state and federal income tax returns?  How often do you stay the night at the house?  The list is not inclusive but are definite factors looked at by the IRS.

Additionally, one must reside in the house as a principal residence for at least two years out of the previous five years in order to qualify for the exclusion. However, if the sale was because of a few reasons, you may still be able to qualify for at least a portion of the exclusion.  Some of the special exceptions include: work related move, health related move, divorce or unforeseeable events.  These exceptions each have their own rules that are too extensive to discuss here.  Therefore it is best to consult with your tax preparer or a qualified tax professional.

As you can see, this exclusion is a powerful tool for homeowners!