Sometimes when a homeowner sales their primary residence there can be tax reporting requirements. Generally, this occurs when you have a capital gain on the sale of the home or you sell a home that is not your primary residence (e.g. a vacation home). However, simply having a gain may not be one of the reporting “triggers” so to speak. So when do you have to report your sale and just how do you go about doing so? Read on my friend, read on.
When you must report your sale.
Generally, there are three scenarios where you will be required to report the sale. These are:
- The sale results in a gain and you do not qualify to exclude all of it,
- The sale results in a gain and you choose not to exclude it, or
- The sale results in a gain or a loss and the taxpayer received a Form 1099-S
The exclusion of the gain is discussed below so we won’t elaborate on it here. We’re not sure why you would NOT want to exclude the gain, so we won’t address that point either. But we will spend some time on the last point, if you receive a Form 1099-S: Proceeds from Real Estate Transactions.
Form 1099-S is used by the party that closes the real estate transaction to report it to yourself and the IRS. This may include the settlement agent, the mortgage company, the attorney or the lender. The key point to remember is that if you received the form, the IRS has received it as well. Now this doesn’t mean that the gain is taxable, but it does mean that you have to go through the hassle of reporting it to the IRS. What happens if you don’t? Well, the IRS through it’s matching process is probably going to send you a letter when they don’t see it on your tax return. As such, we recommend that you avoid the hassle and just deal with it on the front end.
Understanding the gain exclusion.
Generally, to qualify for the exclusion, you must meet both the ownership test and the use test. These test are considered me IF you have owned and used your home as your main home for a period totaling at least two out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. Another thing to note is that, generally, you are not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.
If these test are met, a taxpayer can exclude up to $250,000 of the gain if using the single or Head of Household filing status ($500,000 on a return that is Married Filing Jointly).
How to report the sale.
To report the sale, you must know the sales price, the adjusted basis and the resulting gain. The sales price will be pretty easy to determine. The adjusted basis is essentially what you’ve invested in the home; the original cost plus the cost of capital improvements you’ve made. These would include things such as a new roof, a remodeled kitchen, a swimming pool, or central air conditioning. You add these expenses to your original cost to increase your adjusted basis. Conversely, you will also need to subtract any depreciation, casualty losses or energy credits that you have claimed to reduce your tax bill while you’ve owned the house. Once you know the adjusted basis, you subtract it from the sales price and that will be the gain you will report.
To begin the reporting process, you would need Form 8949 Sales and Other Dispositions of Capital Assets. Since the resulting gain is one that transpired during a period longer than one year, it is considered long term. As such, home sales are reported using Part II of the form. Items A-E of the form are pretty self explanatory, but it is items F-H that you will want to pay attention to. Once the proceeds from the sale and the cost are entered, you will have the resulting gain. Column F is where you enter in the code to enter in why you are adjusting the gain. For home sales, this is code H. In column G you enter in the amount of gain that you are excluding as a negative number. Any remaining gain (which is taxable) would then be reported in column H and carried to Schedule D.
Other items to be aware of.
As with anything tax related, nothing is always as simple as it seems. With that being said, here are some more obscure things to keep in mind when it comes time to report your sale:
- The home sale exclusion generally does NOT apply to rental properties. However, if you convert a former rental property to your principal residence, you may be able to exclude a portion of the gain.
- If you or your spouse serve on “qualified official extended duty” as a member of the uniformed services, you can choose to have the five-year-test period for ownership and use suspended for up to ten years.
- In certain cases, you can treat part of your profit as tax-free even if you don’t pass the two-out-of-five-years tests. The key to remember with this is that this doesn’t mean that you can only exclude a portion of your gain. It means that the $200,000/$500,000 exclusion is reduced based on the amount of time you spent in the home during the qualifying period.
- If you inherited your home from your spouse or someone else after their death, your basis will generally be the fair market value of the home at the time the previous owner died. Note that their are special considerations if you live in a community property state or you jointly owned the home with you spouse.
- It is possible to extend the break to a second home by converting it to your principal residence before you sell. However, note that 1) not all the gain will be excludable and 2) calculations will have to be performed to determine how much time the property was used as a rental (if any), primary residence and how much of this occurred after 2008 (when the rules changed)