With the real estate market still so hot, you might be tempted to cash in. If you do, consider the following tax matters when selling a home.
Principal residence exclusion
You may qualify to exclude from income all or part of any gain from the sale of your home (“principal residence exclusion”). To qualify for this exclusion, you must meet ownership and use tests.
1. Ownership test. The homeowner must have owned the home for at least two years of the five-year period ending on the date of the sale.
2. Use test. The homeowner must have used the home as their main residence for at least two years of the five-year period ending on the date of the sale.
Limits on the exclusion
The principal residence exclusion is limited to $250,000 ($500,000 for joint filers). Also, you can only claim the exclusion once during a two-year period.
Note. In certain circumstances, if you fail the two-out-of-five-year ownership and use tests you may still be eligible to claim a partial primary residence exclusion if your main reason for the home sale was a change in workplace location, a health issue or another unforeseeable event.
If you can exclude all your gain on a home sale you do not need to report the sale on your tax return unless a Form 1099-S, Proceeds from Real Estate Transactions was issued to you.
Losses from the sale of a home
If you sell your home at a loss (sell the home for less than its adjusted basis) you can’t deduct the loss.
Note. The IRS provides worksheets to use to figure the adjusted basis of the home sold, the gain or loss on the sale, and the amount of gain on the sale that can be excluded from income. You want to be sure you keep good records of all improvements and repairs you make to the home over the time you live in it. This becomes extremely important in a rising real estate market where your gain could be in excess of the exclusion limits above.
Taxpayers with multiple homes
If you own multiple homes you can exclude gain only from the sale of your principal residence. You can’t exclude any gain from the sale of any other home.
Note. If you own multiple homes you can sell your main home, move to an already owned second home, such as a vacation home, and turn that second home into your principal residence. Once you satisfy the ownership and use tests for the second home, you can exclude gain on the sale of your second residence.
Reporting the sale
If you don’t qualify to exclude all of the taxable gain from your income you must report the gain from the sale of your home when you file your tax return. Don’t want to claim the exclusion? You must report the taxable gain on your tax return. If you receive a Form 1099-S you must report the sale on your tax return even if you have no taxable gain.
When you sell your home for less than the amount of your mortgage (short sale) you can exclude the amount discharged or forgiven from income as long as the amount was discharged before January 1, 2026 or a written agreement for the debt forgiveness was in place before January 1, 2026.
If you have any questions, contact your Henry+Horne advisor.
Jeremy Smith, CPA