2021 Transaction Planning: Sale of Residence
A taxpayer may qualify to exclude from his/her income all or partial gain from the sale of his/her main home. The taxpayer’s main home is the one that taxpayer resides most of the time.
Ownership and Use Tests
To qualify for the exclusion, the taxpayer must meet the ownership and use tests. Therefore, during the 5-year period ending on the date of the sale, the taxpayer must have:
Occupied the home for at least two years (the ownership test)
Lived in the main home for at least two years (the use test)
Gains and Losses
If the ownership and use tests are met, the taxpayer may be able to exclude up to $250,000 of the gain ($500,000 for joint returns) on the sale of the main home. However, loss from the sale of a home is not deductible.
Reporting the sale
The taxpayer must report the sale of the home even if the gain is excludable when the taxpayer receives an informational income-reporting document such as Form 1099-S, Proceeds from Real Estate Transactions. In addition, the taxpayer must report the sale of the main home if the taxpayer cannot exclude all capital gain from income.
More than One Home
If the taxpayer has more than one home, only the gain from the sale of the taxpayer’s main home is excludable. Tax must be paid on the gain from selling any other home. If the taxpayer has two homes and lives in both, the taxpayer’s main home is the one that the taxpayer resides most of the home.
Business Use of Home
The taxpayer may be able to exclude the gain from the sale of a home that the taxpayer has utilized for business purposes or to produce rental income.
To claim the deduction for business use, the taxpayer must meet the following conditions:
The taxpayer must use a part of his or her home specifically for the business purpose;
The taxpayer must use the part of his or her home regularly for the business purpose(the business use is continuous, ongoing, or recurring);
The taxpayer’s business use of the home must be one of the following
The main location of the taxpayer’s trade or business (If the taxpayer has more than one location, the main location is primarily determined by the relative significance of the activities performed at each location; and the amount of time consumed in business activities in each location).
A location to meet patients, clients or customers during the normal course of the taxpayer’s trade or business; or
Use of a separate structure not attached to the home, in connection with the taxpayer’s trade or business if the structure is used specifically and regularly in connection with the taxpayer’s trade or business
Rental of Home
The home rental deduction is applicable if the taxpayer rents out all or a part of his or her home or vacation home.
The deduction is generally capped at the amount of gross income generated from the home rental, decreased by home expenses such as mortgage interest, property taxes, etc. and rental expenses not associated with the use of the home such as office supplies, equipment rent, etc.
There is a further limitation if the taxpayer has used the dwelling unit for personal purposes. Under the limitation, deductible rental expenses are restricted to the amount calculated by the following formula:
A taxpayer is treated as using the unit as a residence if he or she uses it for personal purposes during the tax year for more than the greater of:
14 days; or
10 percent of the number of days during the tax year for which the home is rented at a fair rental price, not taking into consideration any day the home is used for personal purposes.
Suspension of the Five-Year Test Period
If the taxpayer or his/her spouse is on qualified official extended duty in the Uniformed Services, the Foreign Service or the intelligence community, the taxpayer may make the election to suspend the five-year test period for up to 10 years. An individual is on qualified official extended duty if for a period of more than 90 days or for an indefinite period, the individual is:
At a duty station that is more than 50 miles away from his or her main home, or
Living in government housing under government orders
If the taxpayer sold his/her home under a contract that allows for all of part of the selling price to be paid in the future, the taxpayer made an installment sale. The taxpayer may report the transaction under the installment method unless the taxpayer elects out. Even if partial gain is deferred using the installment method, the taxpayer is still eligible for the exclusion of gain if the ownership and use tests are met.