Even when you’re selling your primary residence, you still have to pay taxes because your home is an asset so it attracts taxes like capital gains tax. If your home increases in value, then you have to pay a capital gain tax on that profit. So how do you avoid paying this tax?
The 2-Out-of-5-Year Rule
To qualify for this exclusion rule, you must meet the ownership and use test requirements. According to the Internal Revenue Service, you qualify to remove up to $250,000 (for individuals) and $500,000 (for a joint return) if you have a capital gain after selling your main residence.
The 2-out-of-five-year rule states that you must own and have lived in your residence for at least two out of the last five years before you sold the house. These two years may not be consecutive and you can exclude this amount anytime you sell your home, but this exclusion is only applicable every two years.
You could live in your home for a year, then put it out for rent for three years and you move back in a year before selling the house and you’ll still qualify for the exclusion rule.
Exceptions to the 2-Out-of-5-Year Rule
There are exceptions to the 2-out-of-five-year rule; leaving your home for a while even in the form of a vacation still means that you lived at home. If you were sick and had to be taken to the hospital to recuperate, the time you spent in the hospital or facility still counts towards your 2-year residence requirements.
If you lived in your home for less than 2 years, you might be able to avoid paying the total capital gain tax, but there must be a circumstance that will enable you to qualify for the exception. Below are some exceptions to the eligibility test:
- Separation or divorce
- Death of spouse
- The sale involved vacant land
- You owned a remainder interest and sold that right
- The previous home was destroyed or demolished
- You were serving in the military during the time of ownership
- You bought or give up ownership of the house in a 1031 like-kind exchange
Even if you don’t qualify for the eligibility test, you may still qualify for the partial exclusion of gain because of the following:
- A work-related move
- A health-related move
- Unforeseeable circumstances such as death, destruction of the home, or giving birth to twins or triplets from one pregnancy.
- Becoming eligible for unemployment benefits
You can qualify for a partial exclusion based on the time you spent living in the residence and if you qualify for any of the special situations.
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