Surviving Spouse Home Sale Exclusion Rules

Federal tax law provides a substantial exclusion, allowing homeowners to shield a large portion of the profit from income tax. For a surviving spouse, specific rules exist that can enhance these benefits, offering financial relief during a difficult time. These provisions address the unique circumstances that arise after the death of a spouse and are designed to provide a pathway to the maximum available tax exclusion.

Core Ownership and Use Requirements

To benefit from the home sale exclusion, a taxpayer must satisfy two tests outlined in Internal Revenue Code Section 121. The Ownership Test requires that you have owned the home for at least two of the five years leading up to the date of the sale. This ownership does not need to be held by a single person for the entire period if the property was jointly owned by a married couple.

The second requirement is the Use Test, which mandates that you have lived in the property as your main home for at least two of the five years ending on the sale date. Unlike the ownership test, which can sometimes be met by just one spouse in a married couple, the use test applies to both spouses for the maximum exclusion. The 24 months of required use do not need to be continuous and can be an accumulation of time over the five-year look-back period.

Special Provisions for a Surviving Spouse

When a spouse passes away, the tax code provides specific relief to the surviving spouse regarding the home sale exclusion. A surviving spouse may qualify for the full $500,000 exclusion, the amount for married couples filing jointly, if they sell the home within a specific timeframe. This provision is available provided the sale occurs no later than two years after the date of the spouse’s death. To be eligible for this higher exclusion, the surviving spouse must not have remarried before the date of the sale.

The rules also allow a surviving spouse to count the time their deceased partner owned and lived in the home to meet the two-out-of-five-year tests. If the deceased spouse met the ownership and use tests, their history is added to the surviving spouse’s. This means that even if the surviving spouse was not on the title for the full two years, they can still meet the requirements by including the time their late spouse spent in the home.

Calculating the Gain on the Sale

Determining the taxable gain from a home sale begins with calculating the difference between the sale price and the property’s adjusted basis. The initial basis is the purchase price of the home. This basis is then increased by the cost of any significant capital improvements made over the years, such as adding a room or remodeling a kitchen, resulting in the adjusted basis.

For a surviving spouse, the concept of a “stepped-up basis” is a factor in this calculation. When a property owner dies, the basis of their share in the property is adjusted to its fair market value on the date of death. This can reduce the amount of calculated gain. The application of this rule varies depending on state law. In common law states, only the deceased spouse’s half of the property receives this step-up in basis.

In community property states, a more favorable rule often applies where both halves of the property get a full step-up to the fair market value at the time of death. For example, if a couple in a common law state bought a home for $200,000 and it was worth $500,000 when one spouse died, the new basis would be $350,000 ($100,000 for the survivor’s original half plus $250,000 for the deceased’s stepped-up half).

Reporting the Home Sale on Your Tax Return

The requirement to report a home sale to the IRS depends on whether you have a taxable gain and if you received a Form 1099-S, Proceeds From Real Estate Transactions. If your entire gain is excludable under the rules, and you do not receive a Form 1099-S, you generally do not need to report the sale on your tax return. The 1099-S is issued by the real estate closing agent and reports the gross proceeds from the sale to you and the IRS.

If you receive a Form 1099-S, you must report the sale even if you have no taxable gain. The sale must also be reported if you cannot exclude the entire gain. In these situations, the transaction is detailed on Form 8949, Sales and Other Dispositions of Capital Assets. The information from Form 8949 is then carried over to Schedule D, Capital Gains and Losses.