To qualify for the $500,000 exclusion, the home must have been your primary residence for two out of the past five years. (People who are in the armed forces and are on active duty get additional time.) According to IRS Publication 523, “If you sell your home after your spouse dies (within two years after your spouse dies), and you have not remarried as of the sale date, you can count any time when your spouse owned the home as time you owned it, and any time when the home was your spouse’s residence as time when it was your residence.”
Given that your husband died more than two years ago, you can’t benefit from the exception that allows you to exclude the full $500,000 if otherwise qualified for the exception at the time of your husband’s death and you sold the home within two years of his death. Just because you don’t get the full $500,000 exclusion doesn’t mean that you’re out of luck. It’s never that easy with the IRS.
These are some of the many rules, but the one issue that you raise is whether you get to exclude $250,000 or $500,000 from taxes. In your case, you owned your home with your husband. When your husband died, we’re going to assume that you became the sole owner of the home. So when you sell the home, you will get to exclude $250,000 of profits from IRS taxes. But that’s not the end of the story.
As with anything that has to do with the IRS, your situation is a bit more complicated. For one, the way you’d compute the profit on your sale is to add up what it cost you to purchase the home, what capital improvements you made to the home while you lived in the home and what costs you had to sell the home. The IRS has quite a bit of information to help you compute what is and what is not included in those numbers.
Having said that, your husband owned the home for many years with you. When he died, we could almost say that his half of the home was “sold” to you for federal income tax purposes. Here’s how that would play out: Let’s say that you and your husband purchased the home for $100,000, and when he died the home was worth $500,000 and the home has stayed at about that value until today.
If you sold today, you’d assume that you would have a $400,000 profit. But since your husband owned half of it and you inherited half of it when he died, you inherited his half at the current market value as of the day he died. Let’s say the value of his half at the time of his death was $250,000. The profit on your half would be $200,000, or the difference between your half of the sales price of $250,000 and your half of the purchase price of $50,000.
On your husband’s share of the home, you inherited the home at a value of $250,000 and are now selling that share for $250,000. That means that you’d pay no tax on the sale of his half when you sell and you wouldn’t pay any tax on your half since the profit on your half is under the $250,000 exclusion you’re allowed. If this is how the numbers were to play out, you wouldn’t have any federal income taxes to pay on the sale of the home.
On a side note, if the home’s value has appreciated since the death of your husband, you might have to pay some tax on the amount the home has appreciated, but only on the appreciation on his half that you inherited. If the home appreciated by $40,000 since his death, you’d pay capital gains taxes on half of that appreciated value and pay capital gains taxes on only $20,000.
Depending on your circumstances and the amounts involved in your situation, you might want to talk to an accountant to get more information and make sure that you account for your share of the home and your husband’s share of the home property when you sell.
Ilyce Glink is the creator of an 18-part webinar and ebook series called “The Intentional Investor: How to Be Wildly Successful in Real Estate” as well as the author of many books on real estate. She also hosts the “Real Estate Minute” on her YouTube channel. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them at ThinkGlink.com.