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How Newlyweds Can Maximize the Home Sale Gain Exclusion

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Whether you're getting married for the first or fifth time, it's common for one spouse (or both) to come into the union with homes that they've owned for a while. And that premarital home could have amassed a significant capital gain over time.

An unmarried person may be able to shelter up to $250,000 of gain on the sale of his or her principal residence from federal income tax. But the home sale gain exclusion can be worth twice as much for a married couple if certain conditions are met. Here's what newlyweds need to know to take full advantage of this valuable break.   

Basics of the Exclusion

Unmarried homeowners can potentially exclude gains of up to $250,000, and married homeowners can potentially exclude gains of up to $500,000. To be eligible for this break, you must pass the following two tests:

  1. The ownership test. You must have owned the home for at least two years during the five-year period ending on the sale date.
  2. The use test. You must have used the home as your principal residence for at least two years during the five-year period ending on the sale date.

Once you've tied the knot, you can exclude up to $500,000 of gain from selling a principal residence on your joint tax return, if:

  • At least one spouse passes the ownership test, and
  • Both spouses pass the use test.

If both spouses own principal residences, each spouse can exclude up to $250,000 from the sale of their residence if that spouse passes the ownership and use tests for that property. 

Important: The ownership and use tests are completely independent, so periods of ownership and use don't need to overlap. For purposes of the tests, two years means periods aggregating to 24 months or 730 days.   

Anti-Recycling Test

You also need to pass the anti-recycling test to be eligible for the home sale gain exclusion privilege. To pass this test, you must not have excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally can't recycle the gain exclusion privilege until two years have passed since you last used it.

You can only claim the larger $500,000 exclusion for married-filing-jointly couples if neither you nor your spouse took advantage of the gain exclusion break for an earlier sale within the two-year period. If one spouse claimed the exclusion within the two-year window, but the other spouse didn't, the exclusion is limited to $250,000.

How It Works

Here are some examples that illustrate how the home sale gain exclusion works for newlyweds:

George and Marta recently tied the knot. Prior to marrying, they both owned separate principal residences, and they individually pass the ownership and use tests for their respective residences. In this situation, each spouse can take advantage of a separate $250,000 exclusion. Put another way, each spouse's eligibility for a separate $250,000 exclusion is determined independently, as if the individuals were still unmarried.  

Another couple—Shawn and Zoe—moved into Shawn's house after they got married. Zoe also owns a home that she decided to sell shortly after the wedding. Neither spouse had lived in the other's home before the marriage. After the marriage, they file a joint tax return. How much of the gain from the sale of Zoe's former principal residence can be excluded?

Zoe can exclude up to $250,000 of gain from that sale if she:

  • Owned and used the property as her principal residence for at least two years during the five-year period ending on the sale date, and
  • Didn't exclude gain from any earlier sale within the preceding two years.

Six months later, the couple decides to sell Shawn's home. How much gain can be excluded from the sale of Shawn's principal residence? The couple can exclude up to $250,000 of gain if Shawn individually passes the same ownership and use tests. It doesn't matter if the sale of Shawn's home occurs within two years of the sale of Zoe's home.    

What if the sale of Shawn's home will trigger a gain of more than $250,000? Zoe can still shelter up to $250,000 of gain from selling her home shortly after the marriage. Additionally, if the couple can hold off on selling Shawn's home for at least two years, they can shelter up to $500,000 of gain as a married-filing-jointly couple—if at least two years have elapsed since the sale of Zoe's property.

Exceptional Gains

If you're fortunate enough to have a gain on the sale of your home that exceeds the allowable exclusion, the excess gain is a long-term gain if you've owned the property for over one year. The current maximum federal rate on long-term gains is 20%, but most people won't owe more than 15%. However, you might also owe the federal 3.8% net investment income tax (NIIT) on the taxable portion of your gain, and you might owe state income tax, too.

For More Information

While home prices have cooled off in many areas, your home may still be worth a lot more than you paid for it. If so, the principal residence gain exclusion break can be a big tax saver, especially for newlyweds who are considering unloading homes that they owned prior to tying the knot. Contact your SSB tax advisor to determine the optimal tax treatment for your situation.

 

©  2023

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