Bartos Group BLOG

Introduction: 

In this blog, Mary Bartos with the Bartos Group of Premiere Plus Realty and Craig Couture, CPA break down the most important things homeowners should know about tax obligations when they sell a house. Whether the property was purchased during the pandemic or has been a long-time primary residence, understanding how the IRS treats a sale can make a big financial difference.

This article summarizes the residency and ownership tests, the exclusion available for primary residences, how capital gains apply to second homes, and a few practical tips so sellers can better anticipate their tax obligations.

Residency and Ownership: The Two Tests That Determine Your Tax Obligations

Two simple but vital tests decide whether a homeowner is eligible for the primary residence exclusion or whether the sale will trigger capital gains reporting. The rules focus on ownership and residency.

Ownership is straightforward: the seller must hold title to the property. Residency requires living in the home as a primary residence for at least 24 months during the five-year period that ends on the date of sale. Meeting both tests usually reduces or eliminates the tax on gain from the sale.

What those tests mean in practice

• Ownership: The seller must appear on the title for the property being sold.
• Residency: The seller must have used the property as their main home for at least 24 months out of the 5 years before the sale.

If both conditions are met, the seller may qualify for the primary residence exclusion and dramatically reduce their tax obligations.

Primary Residence Exclusion: The Big Tax Break

The tax code provides a specific exclusion for gains on the sale of a primary residence. The exclusion amount depends on filing status:

• Married filing jointly: up to $500,000 of gain can be excluded.
• Single or married filing separately: up to $250,000 of gain can be excluded.

“There is a $500,000 exclusion on the gain,” Craig explains, summarizing the rule that often eliminates tax on a home sale for qualifying married couples.

Example: if a married couple bought a home for $300,000 and sold it for $800,000, the $500,000 gain would typically be excluded from income if the couple met the ownership and residency tests. That removal of gain from taxable income can eliminate a significant portion of the seller’s tax obligations.

Shorter ownership or residency periods

The 24-month residency requirement does not have to be continuous. If the seller lived in the home for 24 separate months within the five-year window, they qualify. This flexibility matters to people who travel seasonally or maintain a second residence for part of the year.

Spousal Situations and the Two-Year Carryover

There is an important protection if one spouse dies. Married couples who owned and used the home as their primary residence can still claim the full $500,000 exclusion if the surviving spouse sells the property within two years of the other spouse’s death. This rule prevents the surviving spouse from being disadvantaged under the exclusion rules and can impact short-term planning and tax obligations.

Second Homes and Capital Gains

If the property is not a primary residence, the sale does not qualify for the primary residence exclusion. Instead, the sale is treated as a capital gain or loss. The tax rate depends on how long the property was held:

• Short-term capital gain if owned for one year or less — taxed at ordinary income rates.
• Long-term capital gain if owned more than one year — taxed at long-term capital gains rates.

For many people with vacation homes or rental properties, this distinction is where real tax obligations arise, and planning around hold periods can change the tax outcome materially.

Homestead rules, seasonal living, and federal treatment

Claiming a homestead locally or spending part of the year elsewhere does not automatically disqualify the property as a primary residence for federal tax purposes. If you meet the residency test and claim the property as your main home, short seasonal absences will generally not be split up and penalized by the IRS. That means many owners who spend summers elsewhere can still meet the residency requirement and reduce their tax obligations.

Practical Tips to Manage Your Tax Obligations Before a Sale

• Confirm the 24-month residency window and track dates of actual occupancy.
• Keep proof of ownership and records of improvements and selling expenses to reduce taxable gain.
• Consider timing a sale to meet the one-year hold threshold if converting a non-primary property to a saleable long-term capital asset.
• Consult with a tax professional to understand local homestead rules and how they interact with federal rules for tax obligations.

FAQs

How do ownership and residency affect my tax obligations when selling a house?

Ownership ensures you have legal title. Residency requires living in the house as your main home for at least 24 months within the five years before sale. Meeting both typically allows a primary residence exclusion that reduces or eliminates your tax obligations on the gain.

What exclusion amount can I use to reduce tax obligations on a primary residence sale?

Married couples filing jointly can exclude up to $500,000 of gain. Single filers can exclude up to $250,000. These exclusions apply when the ownership and residency tests are satisfied.

If I have a second home, what are my likely tax obligations?

Sales of second homes do not qualify for the primary residence exclusion. Gains are treated as capital gains and taxed either short-term or long-term depending on whether the property was held for more or less than one year.

Can I still get the exclusion if my spouse died?

Yes. If a married spouse dies, the surviving spouse can still claim the full $500,000 exclusion if the property is sold within two years of the date of death and the other requirements were met.

Final Thoughts

Selling a home involves more than market timing and curb appeal. It also involves understanding the tax rules that determine your tax obligations. Whether the property was bought during the pandemic or years earlier, making sure you meet the ownership and residency tests, knowing when the primary residence exclusion applies, and planning around capital gains can reduce surprises at tax time.

For tailored guidance on a specific sale, consult a qualified CPA or tax professional to confirm how the rules apply to your situation and to help document the records you need to support any exclusion or gain calculation.