Is There a One-Time Capital Gains Exemption for Seniors?

Many people recall an old tax provision allowing a “one-time capital gains exemption” for a home sale. That specific rule, which allowed homeowners over age 55 a one-time exclusion of up to $125,000, was eliminated by the Taxpayer Relief Act of 1997. It was replaced with a new, more broadly available home sale exclusion that is not limited by age and can be used multiple times. The previous law was criticized for creating a “lock-in” effect, where older homeowners might have avoided moving to prevent using their one-time benefit. The current law was designed to remove these barriers, making it a more accessible tool for individuals across different life stages.

The Current Home Sale Exclusion Rule

The modern home sale exclusion, often referred to by its tax code reference, Section 121, allows homeowners to exclude a substantial amount of profit from their taxable income. For a single individual, up to $250,000 of the gain from the sale of a primary residence can be excluded. This amount doubles for married couples who file a joint tax return, allowing them to exclude up to $500,000 of gain. This provision applies to homeowners of any age, removing the previous age-55 requirement. A key feature of the current rule is that it is not a one-time event, providing greater flexibility than the old law. The exclusion is a direct reduction of the calculated capital gain, meaning the profit is not counted as taxable income up to the allowed limits.

Meeting the Eligibility Requirements

To qualify for the home sale exclusion, a taxpayer must satisfy three core tests established by the IRS.

• Ownership Test: You must have owned the home for at least two of the five years immediately preceding the date of the sale. The two years of ownership do not need to be continuous. For example, owning the home for a year, renting it out, and then owning it for another year before the sale would meet this test.
• Use Test: You must have lived in the home as your primary residence for at least two of the five years leading up to the sale. Similar to the ownership test, these two years do not have to be a single, unbroken period. Your primary residence is the one you live in most of the time, which can be established by your voting address, tax returns, and driver’s license.
• Look-Back Test: You cannot have excluded the gain from the sale of another home in the two-year period prior to the current sale. This test ensures a homeowner can use the exclusion repeatedly, but not more than once every two years.

Calculating Your Capital Gain

The home sale exclusion applies to your capital gain, not the total selling price of the house. Calculating this gain begins with the final sale price. From this amount, you subtract any selling expenses you incurred, such as real estate agent commissions, advertising costs, legal fees, and other closing costs. The result is the “amount realized” from the sale.

Next, you must determine your home’s adjusted basis. The basis starts as the original price you paid for the property. This initial basis is then increased by the cost of any capital improvements you made. A capital improvement is something that adds value to your home, prolongs its useful life, or adapts it to new uses. Examples include:

• Adding a new room
• Installing a new roof
• Paving the driveway
• Replacing the entire HVAC system

Simple repairs and maintenance, such as painting a room, fixing a leaky pipe, or replacing a broken windowpane, do not count as capital improvements and cannot be added to your basis. The final calculation is to take the amount realized and subtract your adjusted basis. The remaining amount is your capital gain.

Special Circumstances and Partial Exclusions

Homeowners who sell before meeting the two-year ownership and use tests may still be eligible for a partial exclusion. The IRS allows for a prorated exclusion if the primary reason for the sale is a change in place of employment, a health-related issue, or another unforeseen event. For example, if a new job requires you to move more than 50 miles away, or a doctor recommends a move for medical reasons, you may qualify.

In these situations, the exclusion is prorated based on the portion of the two-year requirement you did meet. If a single filer lived in their home for one year before having to move for a qualifying reason, they could potentially exclude up to $125,000 of gain.

Rules also exist to assist a surviving spouse. If a spouse dies and the surviving spouse sells the primary residence, they may be able to claim the full $500,000 exclusion if the sale occurs within two years of the date of death, provided the other ownership and use conditions were met. The basis of the home may also be “stepped up” to its fair market value at the time of the spouse’s death, which can significantly reduce or eliminate any taxable gain.

Reporting the Home Sale on Your Tax Return

The need to report a home sale to the IRS depends on whether your gain is fully excludable and if you received a Form 1099-S, “Proceeds From Real Estate Transactions.” If your entire gain is covered by the exclusion and you did not receive a Form 1099-S, you do not need to report the sale on your tax return.

Reporting becomes mandatory if any part of your gain is taxable because it exceeds your maximum exclusion amount. You must also report the sale if you received a Form 1099-S, as this form reports the gross proceeds to the IRS. You must also report the sale if you choose not to claim the exclusion.

When reporting is required, the transaction is detailed on Form 8949, “Sales and Other Dispositions of Capital Assets,” and the results are summarized on Schedule D, “Capital Gains and Losses.” On Form 8949, you will list the sale details, including the proceeds, your cost basis, and the excludable amount, to correctly calculate the taxable portion of the gain, if any.