The IRS Ownership Test for Selling Your Home

The Internal Revenue Service (IRS) provides a significant tax benefit to homeowners selling their main residence, officially known as the Section 121 exclusion. This allows individuals to exclude up to $250,000 of the gain from the sale, or up to $500,000 for married couples filing jointly, from their taxable income. To be eligible for this exclusion, a taxpayer must satisfy several conditions. The primary qualification is the ownership test, which examines the duration of ownership to ensure the benefit is reserved for a primary home rather than an investment property.

Core Requirements of the Ownership Test

The foundation of the ownership test is the “2-out-of-5-year” rule. This rule mandates that a taxpayer must have owned the home for at least two years, which equates to 730 days, during the five-year period that concludes on the date of the sale. The five-year window is a look-back period that starts from the closing date of the property sale.

It is a common misconception that these two years of ownership must be a single, continuous block of time. The IRS permits the 24 months of ownership to be accumulated at any point within the five-year look-back period. The IRS defines ownership as having your name on the property’s title.

This look-back structure provides flexibility. For instance, a homeowner could live in a property for a year, rent it out for two years, and then move back in for another year before selling. As long as they owned the property for at least two of those five years, they satisfy this test.

Interaction with the Use Test

The ownership test does not stand alone; the IRS pairs it with a use test. A homeowner must meet both to qualify for the home sale exclusion. The use test dictates that the taxpayer must have lived in the home as their primary residence for at least two of the five years leading up to the date of sale.

A taxpayer must satisfy both the ownership and use tests during the five-year period ending on the sale date, but the two-year periods for each test do not have to be the same. An individual could meet the ownership test during one two-year span and the use test during a different two-year span within the same five-year look-back period.

For example, someone could own a home for five years but only live in it as their main residence for the first two years before renting it out for the remaining three. In this scenario, they would meet both tests and could qualify for the exclusion. Failing either test will disqualify a homeowner.

Special Rules and Considerations

The standard ownership rules have several modifications to accommodate common life events. These adjustments provide flexibility for taxpayers in unique situations, ensuring the tax benefit remains accessible.

Married Couples

When a married couple files a joint tax return, the ownership test rules are relaxed. Only one spouse needs to meet the two-year ownership requirement to qualify for the maximum $500,000 exclusion. However, both spouses must typically meet the separate use test to claim the full exclusion amount.

Surviving Spouses

In the event of a spouse’s death, the surviving spouse can receive credit for the time the deceased spouse owned the home. If the surviving spouse has not remarried before the sale date, they can add the deceased spouse’s ownership period to their own to meet the two-year requirement. This provision helps a surviving spouse avoid losing the tax exclusion.

Divorce

The ownership rules also account for property transfers during a divorce. If a home is transferred to an individual as part of a divorce settlement, that person can count the time their former spouse owned the property as their own period of ownership. This applies only to the ownership test, not the use test.

Military and Government Personnel

Members of the uniformed services, Foreign Service, or intelligence community on qualified official extended duty have a special provision. They can elect to suspend the five-year test period for up to 10 years. This allows service members who are deployed or stationed away from their main home to still meet the ownership and use tests.

Partial Exclusion

A taxpayer who sells their home but fails to meet the full two-year ownership or use tests may still be eligible for a partial exclusion. This is available if the primary reason for the sale is a change in health, a change in place of employment, or other unforeseen circumstances as defined by the IRS. The partial exclusion is prorated based on the portion of the two-year period that the taxpayer did meet.

Proving Ownership and Reporting the Sale

To substantiate a claim for the home sale exclusion, a taxpayer must be able to prove they met the ownership test. The IRS accepts several documents as proof of ownership, including the property’s deed, settlement statements from the purchase and sale, and property tax records.

A homeowner does not always have to report the sale of their main home to the IRS. Reporting becomes mandatory if the taxpayer receives a Form 1099-S, Proceeds From Real Estate Transactions. Reporting is also required if the gain from the sale is more than the maximum exclusion amount. In these cases, the sale must be reported on Form 8949 and Schedule D (Form 1040).