What should I do if I don’t qualify for the full home sale exclusion? This wants to know if they have any other options to reduce taxes on the home sale.

Q: We’re a French family moving back to France next year. I read that a married homeowner who has lived in his principal residence for two out of the last five years is entitled to exclude from federal income taxes up to $500,000 in profits. 

We bought the house less than 2 years ago. What happens in this case? On a separate note, we were relieved to find out that we won’t have to pay for the FIRPTA. It was very confusing. We purchased our multi-unit building in 2018 for $740,000 and we will be selling it next year for around $760,000.

What Should I Do If I Don’t Qualify for the Home Sale Exclusion?

A: We hate to burst your bubble, but the home sale exclusion rule will likely not apply to you in any event. If you purchased your home for $740,000 and sell it for $760,000, you’ll likely have no profit on the sale after paying closing costs, commissions and expenses. Without a profit, you won’t have any taxes to pay. 

The Internal Revenue Service would tell you that the cost (or basis) for your home is what you paid for the home plus any closing costs you had at the time of your purchase. Once you purchased your home, your basis would increase if you improved the home or had other expenses that the IRS allows toward the basis of your home. You can get more information on determining the basis of your home from Publication 523, Selling Your Home on IRS.gov. 

Closing costs on your sale that reduce what you’d pay in taxes include the cost of closing, title insurance, survey expenses, transfer taxes, recording fees, attorney’s fees, etc. Your basis is also increased by your closing costs when you sell your home.

If we assume that you would have a profit on the sale of the home, the IRS has a home sale exclusion that allows an individual to exclude from any federal income tax up to $250,000 in profit from the sale of the home. If you are married, you get to exclude up to $500,000 in profit from federal income taxes. The rule requires you to have resided in the home for two out of the last five years and the home must have been your primary residence. 

Partial Exclusion

In some situations, the IRS will allow a partial exclusion when the homeowner fails to meet the two-year test when the failure is due to divorce, death, work-related relocation, or a health-related move. For more details on the partial exclusion, we refer you again to the IRS Publication 523.

You might fall into the work-related provision that might have given you a partial exemption. The job relocation must be for a new job at least 50 miles farther from the home than the old job location. If you were to qualify for this partial exclusion, you’d have to compute the amount of time that you lived in the home and you might then be entitled to a reduced exclusion amount.

Let’s say you lived in the home for one year and you otherwise qualify for the exclusion. Given this example, you lived for half of the required years in the home and you might be entitled to exclude from federal income taxes up to $125,000 in profit on the sale of your home if you’re single and $250,000 if you are married. (You’ll need to go over each and every requirement in Publication 523 on the IRS website to make sure you qualify.)

As you are not a U.S. citizen, and you are going back to France, you might have a more unique situation. We can’t go into the details here, but foreign residents leaving the United States have certain responsibilities and requirements that would determine your eligibility for the home sale exclusion. 

What Is the FIRPTA?

While it’s unlikely that you will have any profit on the sale of your home, you mentioned FIRPTA. FIRPTA is the Foreign Investment in Real Property Tax Act. This act was passed by Congress to prevent foreigners from leaving the country without paying taxes they owe. In a residential transaction, every seller must tell his or her buyer that the seller is not subject to income tax withholding by the IRS. 

The FIRPTA law places a burden on a buyer of residential real estate to make sure the tax is collected. So, if a buyer is purchasing a home, the buyer must get an affidavit, under penalty of perjury, from the seller stating that the seller is not a foreign person along with the name of the seller, the U.S. taxpayer identification number and home address for the seller. For more information on FIRPTA, you can read about it on the IRS website under Exceptions from FIRPTA withholding.

When the sales price is $300,000 or under and the buyer will use the home as their principal residence, the buyer is exempt from the withholding requirements.

If the seller does not or refuses to deliver the affidavit, the buyer must withhold 15 percent of the sales price and then follow the IRS instructions for the withholding and the payment of the withheld money to the IRS. The seller would then have to apply to the IRS to get a return of all or a portion of the funds depending on any taxes owed by the seller.

Au revoir.

More on Topics Related to What Should I Do If I Don’t Qualify for the Home Sale Exclusion? 

Can a Non-Citizen Buy a House in the U.S.?

If I Get Divorced and Then Sell my Home, Can I Still Take the $250,000 Exclusion?

How Do I Avoid Capital Gains Tax on the Sale of a Second Home?

The Tax Implications of Renting Out Your Home

Six Tax Planning Tips for Selling Your Home