IRS Taxation of the Sale of Personal Residence, Often Without Audit or Much Advanced Notice to the Taxpayer - Part 1 of 2 - Crowley Fleck Law (2024)

FAQs

What is Section 121 sale of personal residence? ›

The Section 121 Exclusion is an IRS rule that allows you to exclude from taxable income a gain of up to $250,000 from the sale of your principal residence. A couple filing a joint return gets to exclude up to $500,000. The exclusion gets its name from the part of the Internal Revenue Code allowing it.

The Capital Gains Tax in California

The amount you earned between the time you bought the property and the time you sold it is your capital gain. The IRS charges you a tax on your capital gains, as does the state of California through the Franchise Tax Board, also known as the FTB.

Whether your small business focuses on real estate or sold unneeded property during the tax year, a copy of form 1099-S, which is sent to both you and the IRS by the closing attorney or real estate official, reports the gross proceeds from the sale.

Exceptions to the 2-out-of-5-Year Rule

You might be able to exclude at least a portion of your gain if you lived in your home less than 24 months but you qualify for one of a handful of special circ*mstances such as a change in workplace, a health-related move, or an unforeseeable event.

For example, a death in the family, losing your job and qualifying for unemployment, not being able to afford the house anymore because of a change in employment or marital status, a natural disaster that destroys your house, or you or your spouse have twins or another multiple birth.

Reporting the Sale

Report the sale or exchange of your main home on Form 8949, Sale and Other Dispositions of Capital Assets, if: You have a gain and do not qualify to exclude all of it, You have a gain and choose not to exclude it, or. You received a Form 1099-S.

Typically, when a taxpayer sells a house (or any other piece of real property), the title company handling the closing generates a Form 1099 setting forth the sales price received for the house. The 1099 is transmitted to the IRS.

Reporting the Sale

If you receive an informational income-reporting document such as Form 1099-S, Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable.

If you owned and lived in the home for a total of two of the five years before the sale, then up to $250,000 of profit is tax-free (or up to $500,000 if you are married and file a joint return). If your profit exceeds the $250,000 or $500,000 limit, the excess is typically reported as a capital gain on Schedule D.

How often does IRS audit home sales? ›

According to CNBC, your chances of being audited are only about 1 in 220 (roughly 0.45%). The exact things that can trigger an audit vary from year to year, but the IRS tends to keep an eye out for excessive deductions, misfiled capital gains, and repeated losses.

When you sell your home, federal tax law requires lenders or real estate agents to file a Form 1099-S, Proceeds from Real Estate Transactions, with the IRS and send you a copy if you do not meet IRS requirements for excluding the taxable gain from the sale on your income tax return.

You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.

Gains must be reinvested within 180 days of the day they are recognized as taxable income. Step-up in basis: The longer you hold onto a property, the more you can increase the basis under which the fair market value of your property is calculated for tax purposes.

How do I avoid the capital gains tax on real estate? If you have owned and occupied your property for at least 2 of the last 5 years, you can avoid paying capital gains taxes on the first $250,000 for single-filers and $500,000 for married people filing jointly.

Current tax law does not allow you to take a capital gains tax break based on age. In the past, the IRS allowed people over the age of 55 a tax exemption for home sales. However, this exclusion was closed in 1997 in favor of the expanded exemption for all homeowners.

The over-55 home sale exemption was a tax law that provided homeowners over age 55 with a one-time capital gains exclusion. Individuals who met the requirements could exclude up to $125,000 of capital gains on the sale of their personal residences. The over-55 home sale exemption has not been in effect since 1997.

Seniors can reduce their capital gains taxes by taking the standard deduction when filing their taxes. Sell Assets in Installments: Selling assets in installments can help seniors spread the tax liability over multiple years, reducing the overall tax burden.

How do I avoid capital gains tax on a second home? There are various ways to avoid capital gains taxes on a second home, including renting it out, performing a 1031 exchange, using it as your primary residence, and depreciating your property.

The proceeds from a home sale can be used in a variety of ways. With up to $500,000 available tax free, you could use the money to make a down payment on another home, pay down problematic debt, increase your stock portfolio or implement strategies to improve your retirement plan.

What are the basic requirements to exclude the gain on the sale of a personal residence quizlet? ›

The taxpayer must have owned the property for at least two years during the five-year period ending on the date of the sale. b. The exclusion of the gain on the sale of a personal residence can only be used once every two years.

Long-term capital gains tax rates for the 2023 tax year

In 2023, individual filers won't pay any capital gains tax if their total taxable income is $44,625 or less. The rate jumps to 15 percent on capital gains, if their income is $44,626 to $492,300. Above that income level the rate climbs to 20 percent.

Put simply: In real estate, the cost basis is the original value that a buyer pays for their property. This includes, but is not limited to, the price paid for the property, any closing costs paid by the buyer and the cost of improvements made (excluding tax credits associated with improvements).

Who gets audited by the IRS the most? In terms of income levels, the IRS in recent years has audited taxpayers with incomes below $25,000 and above $500,000 at higher-than-average rates, according to government data.

Failing to report all your income is one of the easiest ways to increase your odds of getting audited. The IRS receives a copy of the tax forms you receive, including Forms 1099, W-2, K-1, and others and compares those amounts with the amounts you include on your tax return.

Missing capital gains

If you fail to report the gain, the IRS will become immediately suspicious. While the IRS may simply identify and correct a small loss and ding you for the difference, a larger missing capital gain could set off the alarms.

Generally, the IRS can include returns filed within the last three years in an audit. If we identify a substantial error, we may add additional years. We usually don't go back more than the last six years. The IRS tries to audit tax returns as soon as possible after they are filed.

Determine your realized amount. This is the sale price minus any commissions or fees paid. Subtract your basis (what you paid) from the realized amount (how much you sold it for) to determine the difference. If you sold your assets for more than you paid, you have a capital gain.

Since IRS Form 8300 revolves around noteworthy cash transactions of $10,000 or more, the Internal Revenue Service takes the documentation very seriously to combat money laundering. Therefore, IRS Form 8300 may trigger an audit though it is not a given.

Who is exempt from 1099 s? ›

Additionally, a 1099S is not required for the sale or exchange of a principal residence with gross proceeds of $250,000 or less ($500,000 or less for married filing jointly) if an acceptable written assurance (certification) from the seller is obtained that indicates the full gain is excludable from the seller's gross ...

Some red flags for an audit are round numbers, missing income, excessive deductions or credits, unreported income and refundable tax credits. The best defense is proper documentation and receipts, tax experts say.

Estate Tax Return Statute of Limitations

In general, IRC 6501(a) requires the IRS to assess an estate tax liability within three years after the filing date (or due date, if later) of the estate tax return.

What Is the 1099 Form Used for? The 1099 form is used to report non-employment income to the Internal Revenue Service (IRS). Businesses are required to issue a 1099 form to a taxpayer (other than a corporation) who has received at least $600 or more in non-employment income during the tax year.

If you forget to report the income documented on a 1099 form, the IRS will catch this error. When the IRS thinks that you owe additional tax on your unreported 1099 income, it'll usually notify you and retroactively charge you penalties and interest beginning on the first day they think that you owed additional tax.

If that happens to you, then you'll likely receive a notice in the mail from the IRS saying that you owe back taxes on the income that wasn't reported on your tax return. The notice you receive will likely include interest on taxes due from the due date of the return to 30 days from the date on the notice.

If the home you sell was in your name and was your primary residence for the two out of five years, you may not have to pay taxes on the full amount of your profits. It's called the “2 out of 5 year rule.” It lets you exclude capital gains up to $250,000 (up to $500,000 if filing jointly).

The 2-out-of-five-year rule states that you must have both owned and lived in your home for a minimum of two out of the last five years before the date of sale. However, these two years don't have to be consecutive, and you don't have to live there on the date of the sale.

How Often Can You Claim the Capital Gains Exclusion? You can exclude capital gains from the sale of a primary residence once every two years. If you want to claim the capital gains exclusion more than once, you'll have to meet the usage and ownership requirements at a different residence.

Do I have to reinvest profit from house sale to avoid capital gains? ›

You can't avoid capital taxes by reinvesting in real estate. You can, however, defer your capital gains taxes by investing in similar real estate property.

Report the sale or exchange of your main home on Form 8949, Sale and Other Dispositions of Capital Assets, if: You have a gain and do not qualify to exclude all of it, You have a gain and choose not to exclude it, or. You received a Form 1099-S.

Relevant Holding Period for Sale of a Carried Interest.

If a partner sells its “carried interest” in a partnership, the gain will generally be long-term capital gain only if the partner has held the “carried interest” for more than three years, regardless of how long the partnership has held its assets.

Qualifying for the Exclusion

In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You're eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale.

EXCLUSION REQUIREMENTS

IRC section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for certain taxpayers who file a joint return) of the gain from the sale (or exchange) of property owned and used as a principal residence for at least two of the five years before the sale.

Reporting the Sale

Report the sale or exchange of your main home on Form 8949, Sale and Other Dispositions of Capital Assets, if: You have a gain and do not qualify to exclude all of it, You have a gain and choose not to exclude it, or. You received a Form 1099-S.

You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.

How do I avoid the capital gains tax on real estate? If you have owned and occupied your property for at least 2 of the last 5 years, you can avoid paying capital gains taxes on the first $250,000 for single-filers and $500,000 for married people filing jointly.

Estates and Section 121

It can apply to a will, probate, trusts, joint tenants (right of survivorship), transfer on death deed, and more. And each of these types of estates can vary in how they were set up.

Under what circ*mstances can a taxpayer obtain a partial exclusion if a home is sold before the use and ownership tests are satisfied? ›

If you don't meet the Eligibility Test, you may still qualify for a partial exclusion of gain. You can meet the requirements for a partial exclusion if the main reason for your home sale was a change in workplace location, a health issue, or an unforeseeable event.

Section 1.121-3(e)(1) provides that a sale is by reason of unforeseen circ*mstances if the primary reason for the sale is the occurrence of an event that the taxpayer could not reasonably have anticipated before purchasing and occupying the residence.

Non-qualified use means the period during which home was not used as the principal residence. Gain allocable to non-qualified use period is taxable as capital gain. The non-qualified use period does not include: The period after the last date the home was used as principal residence until the date of sale.

Determine your realized amount. This is the sale price minus any commissions or fees paid. Subtract your basis (what you paid) from the realized amount (how much you sold it for) to determine the difference. If you sold your assets for more than you paid, you have a capital gain.

If you owned and lived in the home for a total of two of the five years before the sale, then up to $250,000 of profit is tax-free (or up to $500,000 if you are married and file a joint return). If your profit exceeds the $250,000 or $500,000 limit, the excess is typically reported as a capital gain on Schedule D.

Use Form 4797 to report: The sale or exchange of property. The involuntary conversion of property and capital assets.