How Long Do You Need to Own Your Home to Escape Capital Gains Taxes on the Sale of It?

The Internal Revenue Code provides taxpayers with an array of tax benefits related to home ownership. The benefits range from the deduction of mortgage interest and real estate taxes to first-time home buyer tax credits. However, the potential to exclude capital gains taxes when you sell a home can provide the most valuable benefit if a home is purchased at a much lower price than sold for.

Tax Basis

• A home's tax basis represents all allowable costs paid to construct or acquire the property. If you purchased the home, the tax basis will include the purchase price plus qualified settlement costs such as abstract fees, legal fees, surveys, title insurance and transfer taxes. If the home you are selling was self-constructed, the tax basis includes the cost of land, labor, materials, inspection, building permits, and architect and contractor fees. The tax basis of a home is increased for any permanent improvements made after the initial purchase or construction.

Capital Gain

• A personal residence is classified as a capital asset by the IRS and is subject to capital gain rules when it is sold. The amount of gain subject to taxation is calculated as the sales price received minus the home's tax basis. The gain is further categorized as a short-term capital gain if you own it for one year or less. All other gains are categorized as long-term capital gains.

Gain Exclusion

• A maximum of $250,000 in capital gains resulting from the sale of a personal residence may be excluded from taxation if you have not excluded similar gain on another home in the two years immediately prior to the closing date. Additionally, the ownership and use tests require that you own the residence and use it as a main home for two years within the five-year period ending on the date of sale. If you are unable to meet the requirement of the use test because you used the home for less than two years, a reduced exclusion is available.

Married Taxpayers

• If you and a spouse own the property jointly but file a separate tax return, each taxpayer can exclude up to $250,000 in gain. Married taxpayers who file a joint return are eligible to exclude $500,000 in gain on the joint return. However, all taxpayers must meet each requirement individually. In the event one spouse does not meet the requirements, only $250,000 in gain can be excluded.

Exclusion Is Elective

• Exclusion of the capital gain from taxation is not automatic; you must calculate and report the exclusion amount on your tax return. You may include the gain on the tax return and pay the appropriate amount of tax if deemed advantageous. Any tax decision made in the year of sale is not binding. You can amend a tax return to either revoke the exclusion or to elect it, provided it is done within three years of the original tax return due date.