Tax Know-How on Ownership and Use Tests for Home Sellers

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Selling homes can incur tax consequences. But there are circumstances in which a homeowner can get tax relief from a sale.

There is an exclusion break for sellers. They can "exclude," meaning escape taxes on as much as $500,000 in profit for married couples filing jointly and $250,000 for those who file single returns or are married and file separate returns. Remember, that's profit, not sales price.

What if the profit is greater than the exclusion amount of $250,000 or $500,000? The excess is taxed as a long-term capital gain. For most sellers, the maximum rate is 15 percent. But the rate can go as high as 20 percent (23.8 percent for those who are liable for the Medicare surtax), plus applicable state taxes.

The exclusion isn’t a one-time opportunity. A seller can claim it as often as every two years. To qualify, she must pass two tests. First, she has owned and lived in the property as her principal residence or main home for at least two years out of the five-year period that ends on the date of sale. Second, she hasn’t excluded gain on another sale of a principal residence within the two years that precede the sale date.

Those two years needn’t be consecutive; they can be off and on for a total of two full years. Short temporary absences for vacations or other seasonal absences count as periods of owner use. This holds true even if she rents out the property during the absences.

The IRS figures the ownership and use tests separately. Under this pro-taxpayer approach, the exclusion is available when, for example, an apartment dweller buys her apartment after the building goes condominium and moves elsewhere before she sells the apartment. The law doesn’t require her to own and use the dwelling simultaneously for at least two years. For exclusion purposes, the period of apartment use and condominium ownership needn’t involve the identical period of years.

Partial exclusion 

There’s tax relief in the form of a partial exclusion for someone who sold another home within the previous two years or fails to satisfy the ownership and use requirements. The partial exclusion becomes available when the primary reason for the sale is health problems, a change in employment, or certain unforeseen circumstances. They include divorce or legal separation, or natural or man-made disasters that cause residential damage—for instance, back-to-back hurricanes Harvey and Irma.

To illustrate, she’s single, have lived in her dwelling for just 12 months and moves to a new job in another city. She can exclude gain of as much as $125,000—12 months divided by 24 months, or 50 percent times $250,000.

Principal residence 

This means the place she lives most of the year, as opposed to a vacation dwelling or property for which she charges rent.

The exclusion isn’t limited to the sale of a conventional single-family home. Her principal residence also can be a condo, a cooperative apartment, her portion of a multi-unit apartment building, a house trailer, a mobile home or anything else that provides all the amenities of a home, such as a houseboat or yacht that has facilities for cooking, sleeping and sanitation, or even a vacation retreat that you move into after retirement.

The location of the principal residence doesn’t matter. It can be in a country other than the United States.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 225 and counting). 

About Julian Block

Julian Block

Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com

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Oct 24th 2017 20:11

i have a client who owns 2 homes - husband owns the main residence and the wife owns her former home. wife has been trying to sell her home for last 12 months unsuccessfully and is considering turning the home back into the bank to stop the outflow of cash - mortgage, utilities etc. house has been vacant for 14 months and the clients wife ex spouse lived in the house prior to walking away 9/16. would my client have any forgiveness of debt if they turn in the house to their mortgage company since the debt would be forgiven or does the value of the home satisfy the outstanding debt. client owes $330K and has been unsuccessful in selling the house to date. client would not be able to pay taxes on forgiveness of debt.

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to sgrishman
Oct 25th 2017 14:22

It's unclear from the wording of your query whether you're aware the tax break for home owners on forgiveness of debt went off the books at the close of 2016. As of now, it has not been renewed for 2017. That being so, perhaps you'd like to reword your query. I look forward to hearing from you.

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Oct 25th 2017 15:00

i was not aware that the tax break for forgiveness of debt for homeowners went off the books at the close of 2016. my client will have to turn her home over to her mortgage company 1/18 if she is unable to sell the home by 12-31-17. will this create a taxable event for the debt forgiveness where my client would be saddled with income of $330K which is the value of the outstanding mortgage? the client cannot pay the monthly mortgage payment and will not be able to pay the potential taxes on the debt forgiveness.
it would seem reasonable to wait until 2018 to let the mortgage company take back the house to defer the potential effect of the tax consequence related to $330k debt forgiveness. And maybe hope for the renewal of the tax break? thank you for you response.

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Oct 25th 2017 19:18

i did not get your new reply.
thank you

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to sgrishman
Oct 25th 2017 19:36

Based on what you've stated, it does seem that your client will be liable for taxes on the forgiven debt.

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