As the housing market recovers, we are seeing more clients who are selling their homes, either an investment home or their personal residence, at a gain.  While the IRS wants its share of any income—whether personal or business—there is a tax break available to those who have used their home as a personal residence.

Under IRS Section 121, taxpayers selling their principal residence at a gain are allowed to exclude $500,000 for married taxpayers and $250,000 for those filing single from the overall gain.  Gain is defined as the difference between the selling price less selling expenses, and the cost basis (purchase price plus any improvements made to the home).

To qualify as a principal residence, a home must be occupied by the homeowner for at least two years within the five-year period ending on the date of the sale.  In addition, there are some exceptions (such as health reasons, etc.) to the two year rule.

In the past, if the home was converted to a rental, the general rule was that at least the portion of the gain that was attributed to rental use would be taxable, with the overall exclusion reduced for the non-qualified use.  However, an IRS ruling in 2008 changed this treatment, creating a tax break for those who used their homes first as principal residences, then converted them to rentals.

Now, if the home was first used as a principal residence (and meets the two-year occupancy test), and is then converted to a rental and subsequently sold at gain within the five year time frame (remembering that the home must be occupied by the owner for two out of the last five years), the full exclusion will apply to any gain.  The taxpayer will be taxed on any depreciation deducted during the time the house is a rental, but may apply the full $500,000 or $250,000 to the overall gain.

If you are considering selling your home and taking advantage of this tax break in a rising market, make sure to contact us at Godecke Clark to review your circumstances.  Good tax planning can save you more than you might think on your tax bill!

Kelli Cox








Kelli Cox, CPA