When you sell your home for more than you have invested in it, you realize a gain in the eyes of the Internal Revenue Service. If you meet certain IRS requirements, you can usually exclude these profits from your taxable income. However, if the home you sold was previously an investment property, your tax situation becomes more complicated.
To exclude gains on the sale of a home from your taxable income, you must pass the IRS ownership and use tests. You will pass the ownership test if you were the home's legal owner for at least two of the five years immediately preceding the sale. You will pass the use test if you used the property as your main home for at least two years during the same time period. If you pass both of these tests, you can exclude up to $250,000 of gains as a single filer or up to $500,000 if you file jointly with a spouse.
If you qualify to exclude gains you realized on the sale of your home, you can exclude only those gains that the IRS doesn't attribute to nonqualified use of the home. Nonqualified use occurs when neither you nor your spouse is using the home as a primary residence. If you were using the home as an investment property during the five years before the sale, every day that the home wasn't your primary residence during that time counts as nonqualified use.
Figuring Your Exclusion
To calculate the taxable amount of your gain, you must first determine the total number of days you owned the home during the past five years, as well as the number of days during this time that count as nonqualified use. Divide the days of nonqualified use by the number of days you owned the home and multiply by the gain you realized on the sale. For example, if you realized a gain of $150,000, owned the home for 2,000 days and used it as an investment property for 800 days, your taxable gain is $60,000 (800 divided by 2,000 and multiplied by $150,000).
If you don't meet the ownership and use tests, you may still qualify to exclude some of the gain from the sale of your home if you sold the home because of unforeseen circumstances, such as a job-related transfer. If the sale of your home resulted in a loss, you may be able to deduct a portion of the loss from your business income. To calculate the deductible loss, you must determine the amount of the loss that is attributable to business use of the home. The remaining loss is nondeductible.
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