CAPITAL GAINS TAX ON HOMESTEADS
During an income tax revision in 2003, the IRS published a change to the tax code for homeowners. Known as the Section 121 Exclusion, it outlines the rules in which homeowners can limit the capital gains tax on the sale of their primary residence.
Section 121 excludes taxes on the first $250,000 of capital gains for individuals and $500,000 for married couples filing jointly when selling their home . . . with a critical limitation. In the immediate five years prior to the sale of the residence, the sellers must have occupied the home an aggregate of at least two years. They must also provide documentation of capital improvements when establishing the tax basis, much like rent property. Last year, I had several clients who had gains well above the exclusion.
I bring this to your attention because very few homeowners keep adequate records of their capital improvements on their homes. Most homeowners never dream that they will live anywhere long enough to have a $500,000 capital gain on the sale of their residence, but in this market it can happen. It is critical to keep good records to prove capital improvements or risk paying too much to the IRS.