The $250,000/$500,000 home sale exclusion

When you sell a home for more than your cost basis, the difference is a capital gain. The home sale exclusion lets qualifying sellers leave up to $250,000 of that gain out of their taxable income, or up to $500,000 for married couples filing jointly. Gain under the limit is generally not taxed at the federal level.

To get the full exclusion, you generally need to pass all three:

• Ownership: you owned the home for at least 2 of the 5 years before the sale.
• Use: you lived in it as your main home for at least 2 of those 5 years.
• Look-back: you didn't exclude gain from another home sale in the 2 years before this one.

For the $500,000 limit, generally either spouse can meet the ownership test, but both must meet the use test, and neither can have used the exclusion in the last 2 years. If only one spouse qualifies, the couple may still get up to $250,000. Special rules can apply after a divorce or the death of a spouse.

You bought a home for $300,000 and spent $40,000 on improvements, for a basis of $340,000. You sell for $600,000 and pay $15,000 in selling costs, so you net $585,000. Your gain is $585,000 minus $340,000, or $245,000. A single filer who passes the tests could exclude all of it.

If you sell before meeting the 2-year tests, you may still qualify for a reduced exclusion when the main reason is a job change, a health issue or certain unforeseen events. The reduced amount is generally based on how much of the 2-year period you met. A tax professional can help you figure it.

• You rented out the home or used part of it for business.
• You claimed depreciation, which is generally taxable on sale.
• You inherited the home or received it in a divorce.
• You lived in it only part of the time, or turned a rental into your main home.

Keep your purchase and sale closing statements, receipts for improvements and proof of where you lived, such as tax returns or a driver's license. These help support your basis and your eligibility.