Under normal circumstances, if you make a profit when you sell your home, the IRS does not tax it if the capital gain was $250,000 or less for single taxpayers and $500,000 or less for taxpayers married filing jointly. The other condition for this tax break is that you must have lived in the home as your primary residence for two out of the five years leading up to the sale.
However, if you do not qualify for the capital gains tax exclusion because you don’t meet the ownership and use tests and/or because you already used the exclusion within the last two years, and if you are selling your primary residence due to unforeseen circumstances, you may still be eligible for a reduced exclusion.
The IRS defines an unforeseen circumstance as “an event that you could not reasonably have anticipated before buying and occupying that home.” Examples, which the IRS calls “specific event safe harbors,” include the condemnation or destruction of your home (for example, by a natural or man-made disaster or act of war or terrorism), death, unemployment, a change in employment that makes it impossible to pay reasonable basic living expenses, divorce or legal separation, or giving birth to multiples. An improvement in your finances that allows you to buy a different home is not considered an unforeseen circumstance.
There are a couple of caveats to these safe harbors. To meet the unemployment test, you must be eligible for unemployment compensation. Also, “reasonable basic living expenses” as defined by the IRS consist of basic food, clothing, housing, health care and transportation expenses, as well as taxes, court-ordered payments and reasonably necessary expenses related to working.
If your situation does not qualify as one of the IRS’s safe harbors, you may still be able to prove your eligibility for the reduced exclusion.
In addition to unforeseen circumstances, taxpayers may also qualify for a reduced capital gains tax exclusion if they experienced a change in employment during the time the home was being used as a primary residence and the new place of employment is at least 50 miles further from the home than the previous place of employment was. Changes in health can also be a qualifying condition if you sold your home to obtain medical treatment for a qualified individual, could be a parent, child, spouse or other close relative as defined by the IRS.