Many wealth homeowners and interstate commuters, live in multiple locations throughout the year. In some instances, a place that they may not consider a primary residence, can qualify and significantly reduce their capital gains tax.
What is the IRS definition of a primary residence?
The IRS has strict guidelines regarding principal residences. The primary factor that the IRS reviews when a taxpayer alternates between two or more properties for successive periods of time, is the time spent at each property. Specifically, the IRS generally grants primary residence status to the property in which the taxpayer spends the majority of their time during the year. There are other factors that the IRS reviews such as the taxpayer’s place of employment, the address listed on the taxpayer’s federal and state tax returns, driver’s license, automobile registration, and voter registration card.
Why does this matter?
If the property value for one of the homes has increased much more than the other, it may make sense to try to meet the primary residence requirement for the highest value property. For instance, you would much rather apply the capital gains exclusion to a property with a unrealized capital gain of $450,000 than one with a gain of $100,000. This will in turn allow the taxpayer to apply the capital gains exclusion to a high valued property when they eventually sell that home. If you recall, homeowners that meet the IRS use and ownership tests can exclude up to $250,000 of capital gains or $500,000 if married and filing jointly. The exclusion applies to only one sale or exchange every two years, and any sales made before May 7, 1997 are not taken into account. The exclusion does not apply to homes which are not used as primary residences, such as vacation or rental property.
Another factor to consider is where you pay state income taxes. A state that has lower state income tax is a more attractive location for your primary residence than a state with a higher one. Generally, you pay state income taxes for several items based on your primary residence.
More questions? Ask your capital gains tax questions online.
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