Unqualified for home sale exclusion? Salvage ‘partial’ exclusion

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in Small Business Tax,Small Business Tax Deduction Strategies

Due to extenuating circumstances, you may not be able to qualify for the full home sale exclusion ($250,000 singles; $500,000 for married joint-filing couples) when you sell your principal residence. However, if you can’t get the whole loaf of bread, at least you might be able to get a slice of it.

Strategy: Claim a partial home sale exclusion on your personal tax return. In some cases, the tax law permits you to reduce or eliminate the amount of the taxable gain on the sale, even if you don’t meet the full requirements under the tax law.

Here’s the whole story: If you’ve owned and used your home as your principal residence for at least two of the previous five years, you can elect to exclude from tax the first $250,000 of home sale gain ($500,000 for joint filers). The exclusion isn’t available if you have claimed the exclusion within the past two years.

However, if you sell your home without meeting the two-year requirement—or you’ve taken advantage of the exclusion in the past two years—you still may be able to claim a partial exclusion. To qualify, the sale must have resulted from change in employment, a need for medical care or unforeseen circumstances.

A laundry list of reasons

What are “unforeseen circumstances” for this purpose? The IRS has established the following safe harbors under the prevailing regulations:

  • Death
  • Divorce
  • Loss of employment
  • A job change that reduces the ability to pay for the home
  • Multiple births from the same pregnancy
  • Damage from a natural or man-made disaster
  • Taking of property.

If none of these safe harbors applies, the IRS will examine the particular facts and circumstances of the case. The critical factors are whether the home has become less suitable as the principal residence, if your ability to pay for the home has materially decreased and if the reason for the sale could have been reasonably anticipated when you bought the home.

How do you figure the amount available for a partial exclusion? All you have to do is multiply the available exclusion by the appropriate ratio.

Example: You and your spouse have lived in and owned your house as your principal residence for nine months. Due to unforeseen circumstances, you’re forced to sell the home at a $200,000 gain before you meet the two-year requirement.

On these facts, you can exclude up to $187,500 of home sale gain from tax ($500,000 x 9 months ÷ by 24 months). The remaining $13,500 gain ($200,000 – $187,500) is subject to tax at a maximum federal rate of 15%.

Tip: To figure out a partial home sale exclusion amount, use the worksheet in IRS Pub. 523, Selling Your Home.

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