For starters, the home sold must be your primary residence. If you own two or more homes, you must determine which one is your main home. Consider the “facts and circumstances” test.
• Where do you spend the most time?
• Is this address on your Voter Registration Card?
• Is this the address you use for Federal and State Tax Returns?
• Is this the address on your driver’s license or car registration?
• Is the home near to where you work and bank?
• Is the home near to Recreational clubs or religious organizations of which you are a member?
You have determined from above that the home you sold was your primary residence. Now let’s take a look at whether you can exclude capital gain.
• You owned the home and used it as your primary residence (main home) during at least two years of the last five years before the date of sale (closing date). Interestingly, the two
year period does not have to be contiguous. The 24 months of residence can fall anywhere within the five year period.
• You did not acquire the home through a like-kind-exchange during the past five years.
• You did not already claim an exclusion for the sale of a home that occurred during the two year period ending on the date of sale of the home, the gain which you now want to exclude.
The Capital Gain of $250,000 ($500,000 if married filing jointly) is the maximum gain excluded. For example: A married couple filing a joint tax return sells their home for $790,000 which they bought 30 years ago for $200,000. The gain on the sale of the home is $590,000. They meet all the requirements to exclude gain so they may use the $500,000 exclusion to lower the taxable gain from the sale to $90,000.
There are exceptions, a couple of rare automatic disqualifications and Partial Exclusions that may be available, so it is always advisable to consult your tax preparer who knows your specific tax situation. IRS Publication 523 Covers this topic in more detail.