With residential real estate markets surging, significant unrealized gains are piling up for many homeowners. That’s good news if you’re ready to sell, but what about the tax implications? Good question.
Thankfully, the federal income tax gain exclusion break for principal residence sales is still on the books, and it’s potentially a big deal for prospective sellers.
If you’re unmarried, the exclusion can shelter up to $250,000 of home sale gain. If you’re married, it can shelter up to $500,000. Nice!
This is Part 2 of our three-part refresher course on how to navigate the twists and turns necessary to wring the maximum federal income tax savings from the home sale gain exclusion break, which might be more valuable than ever right now.
For Part 1 of our analysis, see Refresher: Principal Residence Gain Exclusion Break (Part 1 of 3). Let’s now get started with Part 2. Here goes.
Take Advantage of the Prorated (Reduced) Gain Exclusion Loophole for “Premature” Sales
What happens when you
fail to pass the principal residence gain exclusion ownership and use tests explained in Part 1 of our analysis, or
run afoul of the anti-recycling rule explained also in Part 1?
Are you just flat out of luck for the gain exclusion? Maybe not.
For example, perhaps you are selling your home for a big profit after living there for only 18 months instead of the required two years, so you fail the ownership and use tests. Or you might be selling your current home less than two years after excluding gain from the sale of a previous residence, so you violate the anti-recycling rule. Rats!
Don’t give up hope.
IRS regulations allow you to claim a prorated (reduced) gain exclusion—a percentage of the $250,000 or $500,000 exclusion that might otherwise be available—in designated circumstances, as you are about to see.
The prorated gain exclusion equals the full $250,000 or $500,000 figure (whichever would otherwise apply) multiplied by a fraction.
The numerator is the shorter of
the aggregate period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or
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