Tax-Free Home Sale: When and Why, You Need to Report to the IRS

 

Tax-Free Home Sale: When and Why, You Need to Report to the IRS

You probably know that when you sell your home, you may exclude up to $250,000 of your gain from tax if you’re unmarried (or married, filing separately) or $500,000 if you are married and file jointly.

To claim the whole exclusion, you must have owned and lived in your home as your principal residence for an aggregate of at least two of the five years before the sale. You can claim the exclusion once every two years.

If your entire gain from a home sale is excluded, do you need to report the sale on your tax return? It depends.

Form 1099-S Issued

A home sale may have to be reported to the IRS by the real estate agency, closing company, mortgage lender, or attorney.

The form used for the home sale is Form 1099-S, Proceeds from Real Estate Transactions. This form lists the gross proceeds from the sale, the property address, and the closing date.

Typically, the 1099-S is issued at the home sale closing and is included in the closing documents the seller receives at settlement.

If the property sale price is more than $250,000 for an individual or $500,000 for a married couple, regardless of the amount of gain, the IRS requires that the sale be reported on Form 1099-S.

If the sale price is less than $250,000/$500,000, Form 1099-S need not be filed if:

• The amount the seller realizes from the transaction is less than the applicable $250,000/$500,000 home sale exclusion, and
• The seller completes and signs a certification under penalty of perjury that the sale qualified for the exclusion. The IRS has created a sample form for this purpose.

However, even if the seller signs such a certification, the agent, closing company, or lender can still choose to file a Form 1099-S. Some do so routinely.

If Form 1099-S is filed, the seller must report the sale on his or her tax return even if the entire gain is excluded from tax.5 Failure to do so will result in the IRS assuming that the gross sale amount is taxable gain. The IRS will issue a proposed adjustment of tax due based on this non-existent gain.

Form 1099-S Not Issued

If Form 1099-S was not issued and there was no taxable gain from the sale, the seller is not required to report the sale on his or her return.

Key point

You have a good reason to report the home sale even if not required. It has to do with the statute of limitations on IRS audits.

Ordinarily, the IRS has a maximum of three years to audit your return and impose a tax assessment. But if you omit more than 25 percent of your gross income from your return, the limitations period is increased to six years. All omitted income items are combined to determine whether the 25 percent threshold is exceeded. Gross income includes gains derived from dealings in property.

If the IRS claims that you improperly excluded your home sale gain from your taxable income (because you didn’t qualify for the exclusion), and if such gain exceeds 25 percent of your gross income, the IRS could assert that you are subject to the six-year limitations period.

You can easily avoid this by reporting the sale on your return. You do this by filing Form 8949 and Schedule D as described below.

Sellers Who Need Not File a Return

Home sellers whose gross income is less than the standard deduction generally need not file a tax return.

For these purposes, gross income includes any gain on a home sale, including gain not subject to tax due to the home sale exclusion. Thus, if the excluded gain plus any other gross income exceeds the filing threshold, a tax return should be filed even if the taxpayer owes no taxes.

Failure to file a return in these circumstances won’t be the end of the world—all the IRS can do is impose a penalty of $485 for failure to file a tax return when no tax was due.

But you win by filing a return, which avoids the penalty and starts the three-year statute of limitations on IRS audits. There is no limitations period at all when no return is filed.

When the return is filed, it is not necessary to report the home sale if Form 1099-S was not filed.

Sellers Who Elect Not to Claim the Exclusion

Home sellers do not have to claim the home sale exclusion if they don’t want to. The only reason not to claim it is if they intend to sell another main home within two years and are likely to receive a larger gain from the sale of that property. In this event, they should report their gain on this sale as taxable gain on their tax return.

Note that sellers can change their mind if things don’t work out as expected—for example, if the later sale never happens, or if the gain turns out to be less than the gain on the earlier sale. Sellers have three years to amend their return for the earlier year and claim the exclusion for that year.

Reporting Home Sale Proceeds to the IRS

Reporting the sale of a principal residence is not difficult. You must file IRS Form 8949, Sales and Other Dispositions of Capital Assets, with your return.

Takeaways

When selling your home, understanding the reporting requirements can save you from unnecessary tax complications. If your entire gain qualifies for the home sale exclusion ($250,000 for singles or $500,000 for couples), you might not need to report it—unless Form 1099-S is issued.

To avoid IRS scrutiny and potential extended audit periods, it’s often wise to report the sale anyway.

Filing IRS Form 8949 and Schedule D ensures clarity and starts the clock on the three-year audit limitation. Even if you’re below the filing threshold, submitting a return can prevent penalties and simplify future dealings with the IRS.

For expert tax planning and advice, contact physiciantaxsolutions.com

This post serves solely for informational purposes and should not be construed as legal, business, or tax advice. Individuals should seek guidance from their attorney, business advisor, or tax advisor regarding the matters discussed herein. physiciantaxsolutions.com assumes no responsibility for actions taken based on the information provided in this post.