Selling a home is always a significant financial event. For business owners, investors, high net worth taxpayers, and families managing large estates, however, it’s also a major tax planning event. If your financial life is more complex than the average taxpayer, understanding and planning around the relevant tax rules is essential for keeping as much of the profit as possible in your pocket.
The IRS taxes profit from real estate sales as capital gains. Any non-excluded profit from the sale of a home that you’ve owned for at least one year would be subject to long-term capital gains rates. If you’ve owned it for a year or less, however, non-excluded profit would be taxed at short-term capital gains rates—which are equivalent to regular income tax rates. Fortunately, however, many homeowners are able to exclude part or all of their home sale profits from federal taxability.
The IRS provides exclusions of home sale profits for homeowners who
If both these conditions are met, an individual taxpayer may exclude up to $250,000 in gains, and homeowners who file joint returns can exclude up to $500,000. As these limits were set in 1997, however, the exclusion isn’t as valuable as it used to be. Home values have multiplied since that time, and many homeowners have seen their home values double within a decade. These days, home sale profits often exceed the exclusion limits. Fortunately, there are other ways to limit the tax implications of the sale.
The IRS home sale exclusion rules may seem straightforward on the surface, but life events often create special circumstances. In some cases, you may qualify for a partial or full exclusion even if you don’t meet the standard tests outlined above.
If your spouse has passed and you do not remarry before selling the home, the IRS allows you to count your deceased spouse’s period of ownership and residence toward meeting the exclusion requirements. So, if your spouse lived in the home longer than you did, you may still qualify for the exclusion based on your spouse’s residential history. Additionally, if you sell the home within two years of your spouse’s death, you could be able to take the entire $500,000 exclusion if all other requirements are met.
If your spouse owned the home and transferred it to you or if you acquired the home as part of a divorce settlement, you can be considered a homeowner for the entire time the home was within your spouse or former spouse’s name. This treatment ensures that a divorce does not automatically penalize one spouse by preventing them from receiving the benefit of exclusion.
Additionally, if you own the home but do not occupy it because your divorce degree grants your former spouse the right to live there, this will not prevent you from meeting the residence test. In this case, the IRS considers the homeowner to be a resident as long as their former spouse retains the legal right to occupy it.
If you inherit a home, your cost basis is the fair market value (FMV) of the property when the original owner died. Even if you do not meet the residency requirement for the inherited home, this still works to limit your tax liability at sale. If, for example, you inherit a home with a current FMV of $1,000,000, you will be in a much better tax position to sell it than a deceased owner who bought it for $300,000 in the 1990s.
If you do not meet the full ownership or residence requirements, you may still qualify for a partial exclusion in certain circumstances such as when the home sale was due to a change in workplace location, a health issue, or other unforeseeable event. For example,
If you’ve encountered an unforeseen event that causes you to sell your home before you’ve met the ownership and residence tests, work with a tax professional to determine if you could qualify for partial exclusion of gains from the sale.
There are strategies you can use to minimize your tax liability when you sell a home. It’s important to carefully plan your strategy and ensure you have all documentation the IRS may require.
One of the most straightforward ways to reduce taxable profit is by increasing your basis in the property. Your basis is the amount of your capital investment in the property for tax purposes. It begins with the purchase price, closing costs, and settlement fees and can increase over time by making certain qualified improvements. Basis does not include repairs and general upkeep but does include upgrades like home additions, new HVAC systems, built-in appliances, roofing, siding, plumbing, and landscaping. For a more complete discussion of how to increase basis in your home, see IRS Publication 523, Selling Your Home.
If you don’t qualify for an exclusion because the home your selling is not your residence, you can use a 1031 exchange to defer taxable gains. Section 1031 of the tax code states:
No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.
For example, if you own a rental property and wish to sell it and purchase a larger multifamily unit, a properly executed 1031 exchange allows you to roll the entire proceeds into the new purchase without paying capital gains tax at the time of sale. Instead, the tax is deferred until the new property is eventually sold without another exchange. This strategy is particularly valuable for business owners and real estate investors who want to grow or diversify their holdings while keeping capital working inside their portfolio. Bear in mind, however, the rules around 1031 exchanges are strict. They include holding periods and tight timelines for identifying and closing on a new property. Because of this, professional guidance is essential when executing this strategy.
Beyond basis adjustments and exchanges, sophisticated taxpayers can minimize their liability with careful timing and structuring of transactions. For example,
Strategies like these require a panoramic view of your financial situation. Since tax planning at the transaction level is just one piece of the broader puzzle, it’s important to work with a tax-planning professional year round to create ongoing, holistic strategies for tax mitigation.
If your gain is fully excluded under IRS rules, you may not need to report the sale at all. You must report the sale, however, in the following cases:
In those cases, sales must be reported on your tax return using Form 8949.
The exclusion limits put in place decades ago don’t come close to reflecting today’s real estate market. For high net worth taxpayers, business owners, and investors, a home sale is rarely just an opportunity to cash in on equity. It’s important to carefully plan the sale, taking your entire financial picture into account, in order to minimize potentially sizable tax consequences.
If you’re thinking of selling a home, especially if it’s tied to your business, an estate, or investment strategy, you need expert guidance to keep your tax bill under control. Stable Rock has the knowledge and experience to help you structure transactions to minimize tax liability and reinvest efficiently.