Capital Gains Exclusion on Sale

Homeowners who sell their primary residence can exclude up to $250,000 (or up to $500,000 for married couples filing jointly) in capital gains from their taxes. The amount of gain that will qualify for the exclusion is limited based on the amount of time that the house is used as a primary residence. If the house is used other than as a primary residence, capital gains must be allocated between qualifying and non-qualifying use. Any non-qualifying use can potentially reduce the amount of capital gain that can be excluded. The allocation rules take effect beginning January 1, 2009.

Qualifying Use vs. Non-Qualifying Use

Taxpayers can qualify to exclude up to $250,000 in capital gains ($500,000 if married and filing jointly) when selling a house. To qualify, the person needs to own and live in the property has his or her primary residence for at least two years out of the five years ending on the date of sale. Sometimes, however, the property isn't used as a primary residence during the entire five-year period. The house might be rented out, used as a vacation home, or used as a second home. Such uses of the home will be considered non-qualifying use and could subject gains from the sale of the house to tax.

For more information:

About.com - Modified Home Sale Exclusion for Non-Qualifying Use
IRS Publication 523