What Is the Look Back Requirement for the Sale of a Home?

The tax benefit for selling a main home allows individuals to exclude a large amount of profit from their taxable income. To qualify, homeowners must satisfy criteria related to their ownership of the property and the time they have lived in it. These requirements, often called “look-back” rules, are defined by the Internal Revenue Service (IRS) to determine eligibility for the tax relief.

The Ownership and Use Tests

The home sale exclusion has two primary requirements: the Ownership Test and the Use Test, and a seller must meet both. The rule stipulates that you must have owned the home and used it as your main residence for at least two of the five years preceding the date of sale. This five-year period is a rolling window that ends on the day the sale closes.

The Ownership Test requires you to have legal ownership of the property for a cumulative total of at least two years within the five-year look-back period. For married couples, the rule is more flexible, as only one spouse needs to meet this ownership requirement for a joint exclusion. This means if one spouse was not on the title for the full two years, the couple could still qualify if the other spouse was.

The Use Test requires that the property served as your principal residence for at least two years during the same five-year period. A principal residence is where you spend the majority of your time, reflected by the address on tax returns, your driver’s license, and voter registration. The two years of use do not need to be continuous. For example, a seller could live in the home for 18 months, rent it out, and then move back in for another six months to meet the 24-month requirement.

Determining the Exclusion Amount

For an individual filer, the maximum gain that can be excluded from income is $250,000. For married couples who file a joint tax return, this amount doubles to $500,000. A qualifying couple who sells their home for a profit of $500,000 or less will likely owe no federal capital gains tax on that profit.

To secure the full $500,000 exclusion, married couples must meet several conditions. They must file a joint return for the year the home is sold. While only one spouse must meet the two-year ownership test, both spouses must individually meet the two-year use test. If these conditions are not met, the exclusion may be limited to $250,000 or a reduced amount.

The Reduced Exclusion for Failing to Meet Requirements

Homeowners who sell their property before fulfilling the two-year ownership and use tests may be eligible for a partial or reduced exclusion. The IRS allows for this prorated exclusion if the primary reason for the sale is a change in employment, a health-related issue, or certain unforeseen circumstances.

A change in employment qualifies if the new job is at least 50 miles farther from the home than the old job was. A health-related move qualifies if a physician recommends a change in residence for medical reasons. Unforeseen circumstances can include events such as the death of a spouse, divorce, or multiple births from a single pregnancy.

Calculating the reduced exclusion involves prorating the maximum available amount based on the portion of the two-year requirement that was met. For example, if a single individual owned and lived in their home for one year (365 days) before selling for a qualifying reason, they would have met half of the two-year (730-day) requirement. They could therefore claim half of the $250,000 exclusion, or $125,000. The fraction used for the calculation is based on the shorter of two periods: the total time of ownership and use, or the time between the current sale and the last sale for which an exclusion was claimed.

Limitations on Claiming the Exclusion

A primary limitation is the frequency with which the benefit can be used. A homeowner can claim the exclusion only once every two years, meaning you must wait at least two years after using the exclusion before you can use it again. This two-year frequency rule is distinct from the five-year period for the ownership and use tests.

Another limitation involves periods of “nonqualified use.” This rule applies to gain earned on a property after December 31, 2008, during periods when it was not used as the taxpayer’s principal residence. For example, if you owned a home for ten years, lived in it for the first five, and rented it out for the next five before selling, the gain attributable to the five-year rental period is from nonqualified use.

The portion of gain from nonqualified use is not eligible for the exclusion and must be calculated separately. The calculation prorates the total gain based on the periods of qualified and nonqualified use. This means only the gain allocated to the period it was your main home is eligible for the exclusion, which can reduce the tax benefit.