Reporting a Tax-Free Residence Sale
Reporting a Tax-Free Residence Sale
Do you communicate the value of this benefit to the clients claiming it?
Individuals can generally exclude up to $250,000 (or $500,000 joint) of gain from selling a primary residence under §121. Even though this generous tax benefit is widely used, the official IRS reporting requirements are pretty lax; however, it is often advisable to report the transaction on the return even if the IRS does not require it.
Scenario 1: No Return Filing Requirement
A taxpayer usually does not have to file a return if their gross income is less than their standard deduction plus personal exemption amount for the tax year. However, §6012(c) includes any gain excluded under §121 in gross income when determining a return filing requirement. Therefore, if the §121 gain excluded plus any other gross income exceeds the relevant threshold based on filing status, the taxpayer is required to file a return, even if the total tax will ultimately be zero.
There is a taxpayer defense reason to file a return: filing a valid return starts the assessment statute of limitations (ASOL) for that tax year, while it will never start if no return is filed under §6501(c)(3). Starting the ASOL by filing a return eventually precludes the IRS from challenging the §121 gain exclusion position provided that it is nonfraudulent.
Scenario 2: Form 1099-S Issued
A residence sale is generally reported to the IRS and the taxpayer on Form 1099-S, Proceeds from Real Estate Transactions. The Instructions for Form 1099-S (Rev. January 2022) provide a reporting exception for certain §121 eligible sales:
Sale or exchange of a residence (including stock in a cooperative housing corporation) for $250,000 or less if you received an acceptable written assurance (certification) from the seller that such residence is the principal residence (within the meaning of section 121) of the seller and the full amount of the gain on such sale is excludable from gross income under section 121. If the certification includes an assurance that the seller is married, the preceding sentence shall be applied by substituting “$500,000” for “$250,000.” If there are joint sellers, you must obtain a certification from each seller (whether married or not) or file Form 1099-S for any seller who does not make the certification. Also, the seller must include in the certification that there has been no period of nonqualified use (as that term is defined in section 121(b)(5)(C)) after December 31, 2008, and as required by section 6045(e)(5)(A)(iii), that the full amount of the gain from the sale is excludable under section 121. The certification must be signed by each seller under penalties of perjury.
The 2023 Instructions for Schedule D on p. D-2 require reporting a residence sale on the return if a taxpayer receives Form 1099-S. If omitted, the IRS will issue a proposed adjustment, assuming the gross sale amount is the taxable gain, which is incorrect.
Scenario 3: Return Filing Requirement and No Form 1099-S
Assuming the taxpayer has to file a return regardless of the residence sale, the 2023 Instructions for Schedule D state on p. D-2 that a taxpayer with no Form 1099-S only reports the residence sale on the return if there is taxable gain from the sale.
Regardless of the IRS instructions, all residence sales should be reported on the tax return for four reasons:
The taxpayer may be unaware that Form 1099-S was issued,
Disclosing the transaction on Form 8949 can foreclose the IRS’s assertion of a six-year ASOL due to the omission of gross income under §6501(e)(1)(B)(iii).
It educates the taxpayer about the net economic outcome of the sale.
It quantifies the value to the taxpayer of the tax professional’s proper determination of the §121 exclusion eligibility and amount.
With respect to the six-year ASOL, Treas. Reg. §301.6501(e)-1(a)(i)(iv) does not require the use of Form 8275, Disclosure Statement, in this circumstance if
…information sufficient to apprise the Commissioner of the nature and amount of the item is disclosed in the return, including any schedule or statement attached to the return.
Reporting the Sale on the Return
A residence sale is reported on Form 8949, Sales and Other Dispositions of Capital Assets, using box F since the transaction is not reported on Form 1099-B, Proceeds from Broker and Barter Exchange Transactions.
The “Proceeds” box should be the unadjusted sale price. If the taxpayer receives Form 1099-S, it will reflect the sale price. The “Basis” box should be the purchase price (or other amount, if applicable) plus any applicable purchase costs (such as transfer taxes, owner’s title insurance, etc.) less certain items (tax credits and depreciation, for example).
Expenses incurred upon the sale of property generally reduce the amount received; however, the Form 8949 instructions state that this should be a negative adjustment in column (g) using code E. This ensures proper matching to Form 1099-S.
If there is a gain on the sale of a residence and some or all of the gain is excluded under §121, the Form 8949 instructions state that this should be a negative adjustment in column (g) using code H.
If a residence is sold for an overall loss, it is a nondeductible personal loss under Treas. Reg. §1.262-1(b)(4). The Form 8949 instructions state that a nondeductible loss should be a positive adjustment in column (g) using code L.
Reporting Example
Paul sold his primary residence for $300,000, which he bought five years ago for $200,000. He had $10,000 in capitalized acquisition costs, $15,000 in improvements, and $24,000 in sale expenses.
His basis in his residence is $225,000, which is the $200,000 purchase price plus $25,000 in additional costs. His amount realized is $276,000, which is the $300,000 sale price less the $24,000 in sale expenses; however, this is presented differently on Form 8949 as the gross sale price is the proceeds listed. Paul has a $51,000 gain that is entirely excluded under §121.
Here is how the transaction is presented on Form 8949:
The total adjustment of $75,000 is the sum of $24,000 in sale expenses and the excluded $51,000 gain.