With soaring home values, many sellers expect a sizable profit when listing their property—and it certainly feels great to get a high price for the sale of your home. However, in some cases, the IRS may want a piece of the action.

That’s because home sales profits are considered capital gains, meaning the difference between what you pay for an asset (your cost basis) and what you sell it for (your sale price) is taxed at federal rates of 0%, 15% or 20%, depending on your income. Luckily, you might qualify for the federal income tax gain exclusion break for principal residence sales, which could serve as a sigh of relief if you’re looking to make a large profit on your home.

How Do Capital Gains Taxes Work on Real Estate?

If you’re unmarried, the exclusion can shelter up to $250,000 of home sale gain. If you’re married, it can shelter up to $500,000. For example, if you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be).

When Do You Pay Capital Gains Tax on Selling a House?

To take full advantage of the principal residence gain exclusion break, certain circumstances must apply. You’ll be on the hook for the capital gains on your home sale if any of these factors are true:

• The house wasn’t your principal residence.
• You owned the property for less than two years.
• You didn’t live in the house for at least two years in the five-year period before you sold it. (People who are disabled, and people in the military, Foreign Service or intelligence community can get an exception; see IRS Publication 523 for details.)
• You already claimed the exclusion on another home in the two-year period before the sale of this home.
• You bought the house through a like-kind exchange in the past five years.
• You are subject to expatriate tax.

What Counts as a Principal Residence?

IRS regulations determine if a property is your principal residence for gain exclusion purposes. If you occupy several residences during the same year, the general rule is that the principal residence for that particular year is the one where you spent the majority of time during that year. Other relevant factors can include, but are not limited to, the following:

• Where you work.
• Where family members live.
• The address shown on your income tax returns, driver’s license, auto registration and voter registration.
• Your mailing address for bills and correspondence.
• Where you maintain bank accounts.
• Where you maintain memberships and religious affiliations.

How Does the Tax Exclusion Work for Unmarried Surviving Spouses?

If you’re a surviving spouse, you’re not allowed to file a joint tax return after the year in which your spouse died—unless you remarry. Which means you’re prohibited from taking advantage of the larger $500,000 joint-filer exclusion.

Thankfully, there’s an exception to this general rule: An unmarried surviving spouse can claim the larger $500,000 exclusion for a principal residence sale that occurs within two years after the spouse’s death, assuming all the other requirements for the $500,000 exclusion were met immediately before the spouse died.

When Should You “Elect Out” of the Gain Exclusion?

As a home seller, you always have the option of “electing out” of the gain exclusion deal and reporting your entire home sale profit as a taxable gain. You make the “election out” by reporting an otherwise excludable gain on Schedule D of Form 1040 for the year of sale.

One circumstance where electing out can be beneficial is when you have two principal residence sales within a two-year period, with the later sale producing a larger gain.

Note: you can retroactively elect out or revoke an earlier election out by filing an amended return at any time within the three-year period beginning with the filing deadline (without regard to any extension) for the year-of-sale return.

How to Mitigate Capital Gains Tax on a Home Sale

When home prices surge, you could stand to make a hefty profit on the sale of your home. Here’s how you can minimize or even avoid a tax bite on the sale of your house:

1. Live in the house for at least two years. If you sell a house that you didn’t live in for at least two years, the gains can be taxable. Selling in less than a year is especially expensive because you could be subject to the costlier short-term capital gains tax.
2. See if you qualify for an exception. If you have a taxable gain on the sale of your home, you might still be able to exclude some of it if you sold the house because of work, health or “an unforeseeable event,” according to the IRS.
3. Keep receipts for home improvements. The cost basis of your home typically includes what you paid to purchase it, as well as improvements made over the years (remodels, expansions, landscaping, etc.). When your cost basis is higher, exposure to the capital gains tax may be lower.

Final Word: Be Aware of Other Tax Consequences

When selling a home for a large profit, there’s also the possibility of other tax consequences. For example, boosting adjusted gross income can impact Medicare premiums and increase the taxes owed on Social Security.

That is why it’s a good idea to meet with a comprehensive financial advisor ahead of time. They can look at your entire financial life to help you identify how selling a home could have unforeseen impacts on other areas of your financial life and come up with a plan to mitigate them.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.