Tax Help - My Home and Capital Gains

Now that the real estate market is in such turmoil, there are lots of folks who have found themselves either having to sell their homes or facing foreclosure. One of the most asked questions is in regard to capital gains tax on the sell of a primary residence.

One of my clients called me last week asking about her situation and here is a snipit of my reply.


“I owned a home for 5 years. I lived in it for the first 2.5 years, then rented it out for the last two and a half. This was also my first sale. I am told many things. Some say I will pay capital gains on the years I rented it (they consider that a business); Some say you don’t have to pay capital gains because you lived in it for 3 years as your primary residence.

And my response to her was to remember two things: 2.5 years out of 5; and $250,000. You must have lived in the home for 2.5 years of the last five (at any interval); and, you are allowed to make $250,000 (single, $500,000 married) before you have to pay capital gains tax.

Now, if you had made $275,000 on the sale, then you have to pay capital gains on the $25,000 difference ($275,000 less $250,000).

Since you’ve lived in the property for 3 years out of the last five, before the sale – the house is treated as your personal residence. There is no capital gain on the sale of the house – as long as the profits are under $250,000 (or $500,000 per couple).

However, since you rented it out, you could have taken deductions for depreciation. When you sell it, you have to pay tax on the depreciation – but only up to 25%, regardless of your tax bracket.

You can read more about it, and use the timeline worksheet in IRS Publication 701.

I strongly urge anyone to have a tax professional prepare this tax return, to make sure you get this one right. It will save you a fortune in the long run.

Related articles:

Frequently Asked Questions - Keyword: Primary Residence
Sale of Residence - Real Estate Tax Tips
Sale of Your Home
Rental Income and Expenses