If you co-own a home with another taxpayer, you can qualify for gain exclusion even if the owner does not.
The Internal Revenue Service, as of 2010, requires taxpayers to report all sales of capital assets that occur during the tax year. Taxpayers who sell a home must provide the IRS with all details of the transaction to determine whether a taxable gain exists. However, unlike most other capital assets, the sale of a home is given extensive tax relief if all requirements are met.
Capital Asset
All property you own for personal use is classified as a capital asset for tax purposes. The definition includes all real estate that taxpayers own. If you own the home for more than one year, any sale or disposition is subject to long-term capital asset rules. All other homes are subject to short-term capital asset rules.
Tax Basis
The tax basis of a home represents the taxpayer's total investment in the real estate. The home's basis includes the purchase price or construction costs; settlement costs, such as abstract, legal and recording fees; surveys; transfer taxes; and title insurance. If you assume a seller's delinquent property tax liability when purchasing the home, you can include those taxes in the home's tax basis. You can increase the tax basis by the amount you pay for permanent home improvements prior to selling the home. This only includes improvements that add to the value of the home, such as the installation of a new roof or finishing a basement. However, this does not include maintenance and repairs.
Calculating Gain
You calculate the gain on the sale of a home by subtracting the home's tax basis on the date of the sale from the gross proceeds or sales price you receive. When calculating gain, you can reduce gross proceeds by any selling expenses you incur. These expenses include commissions, advertising and legal fees, and the loan charges you pay, such as loan placement fees or points.
Gain Exclusion
If the sale of a home results in a capital gain, you may be able to exclude up to $250,000 of the gain from taxation. To qualify, you must not exclude the gain on another home sale under this rule within the two-year period ending on the date of the current sale. The IRS also requires during the five-year period ending on the date of the sale that you use the residence as the main home and have an ownership interest in it for a minimum of two years. If you own the property jointly with a spouse and do not file separate tax returns, you can exclude a maximum of $500,000 in gain.
Reporting
You must report the home sale transaction on the Schedule D attachment to IRS Form 1040 in the year of sale. This requirement applies even if you are able to exclude 100 percent of the resulting gain. The exclusion is only valid if you fully report the transaction and make the exclusion election on a return. If a portion of the gain is subject to taxation, you can use other capital losses to offset the amount of tax you will owe.
