Buying a home is often considered an investment because the value of real estate can increase over time. If you buy a home and sell it for at a price that is higher than what you paid for it, the profit you make is called a "capital gain." Capital gains from selling houses, stocks and other assets are subject to federal taxation, but you can avoid some of the capital gains tax due on the profit from selling a home through a special tax exclusion.
Capital Gains Tax
Capital gains tax is a federal tax applied to the profits you realize when you sell an asset. According to the IRS, the capital gains tax rate is 15 percent for assets you hold for more than a year, while the tax rate on profits you derive from selling assets held less for a year is equal to your normal income tax rate. It is usually preferable to hold investments longer than a year to avoid the higher short-term capital gains tax rate.
Home Sale Exclusion
While capital gains taxes apply to profit from selling homes, the IRS offers a home sale exclusion that may allow you to avoid it. The IRS states that a home sale exclusion of $250,000 applies to single taxpayers and an exclusion of $500,000 applies to married couples filing joint returns. This means that you can make up to $250,000 in profit from selling a home as a single taxpayer or $500,000 as a joint filer without paying any capital gains tax, so long as you qualify for the exclusion.
Qualifying for the Exclusion
To qualify for the exclusion for capital gains on the sale of a home, you must meet home ownership and usage tests. When you sell a home, you must have owned the home for at least two of the past five years and have lived in the home as your main home for two of the past five years to qualify for the exclusion. The $500,000 exclusion for married couples only applies if both partners lived in the home for two of the past five years. In addition, you do not qualify for the exclusion if you took the exclusion on the sale of a different home within the past two years.
You do not have to report profit from the sale of a home on your income tax return if you are able to exclude all of the gain. If you do not qualify for the exclusion or some of the gain exceeds the amount of the exclusion, you have to include profit that you are not able to exclude on your tax return. The IRS says that if you have a gain that you cannot exclude, you should report it on Schedule D of Form 1040.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.