Home Sale Tax Exclusion
The biggest tax break in real estate: you can exclude up to $250,000 in profit ($500,000 for married couples) from capital gains tax when selling your primary residence. This means most Americans pay zero tax on their home sale profit. But there are rules you need to follow.
How the Exclusion Works
- Ownership test — You must have owned the home for at least 2 of the last 5 years before the sale
- Use test — You must have lived in the home as your primary residence for at least 2 of the last 5 years (the 2 years do not need to be consecutive)
- Frequency — You can only use this exclusion once every 2 years
- Example — You bought a house for $300,000, lived in it for 4 years, and sold it for $500,000. Your gain is $200,000. As a single filer, the entire $200,000 is excluded from taxes. You owe $0 in capital gains tax
- Above the exclusion — If married and your profit exceeds $500,000, you pay long-term capital gains tax (0%, 15%, or 20%) only on the amount above $500,000
Reducing Your Taxable Gain
- Add improvements to cost basis — Kitchen renovation ($25,000), new roof ($15,000), bathroom remodel ($10,000) all increase your cost basis and reduce taxable gain. Keep receipts for all home improvements
- Add purchase and selling costs — Original closing costs, title fees, agent commissions (typically 5-6% of sale price), transfer taxes. These all reduce your taxable gain
- 1031 exchange for investment property — If selling a rental or investment property (not primary residence), you can defer ALL capital gains by buying a like-kind property within 180 days. The tax is deferred, not eliminated, but you can keep deferring until death (when step-up in basis eliminates it)