If you live or dwell in the house for two of the five years before you sell, the IRS won't collect tax on sale profit of up to $250,000 if you're single or $500,000 if you and your spouse file a joint return. The stipulation that sellers need be aged 55 or older to qualify, was eliminated with the replacement of IRC 1034, by the "2 out of 5" rule initiated on May 7, 1997.
Currently the law rewards people who sell frequently. In this current market, homeowners who sell every couple of years can benefit.
Still, remember to always keep track of what you paid and what improvements you make. The improvements add to your home's basis, which you subtract from the sale price to determine your profit and whether any of it is taxable.
Surprisingly, many home sellers don't know how to determine their net sales price and their profit of their old home. It's really quite easy.
Home sale profit is the difference between the home's "adjusted sales price" and the "adjusted cost basis."
Adjusted sales price is the same as the net sales price. That's the gross sales price minus selling expense. To illustrate, suppose your home buyer pays $250,000 for your house. But from this money you must pay sales costs of $15,000 for the real estate commission, and $3,000 in miscellaneous other fees. Thus your adjusted or net sales price is $232,000.
Your home's adjusted cost basis is determined by adding (1) your purchase price, (2) most closing costs which were not tax deductible at the time of purchase, and (3) capital improvements added during ownership, and subtracting (1) any depreciation deducted for business use, such as home office and (2) any casualty loss tax deduction claimed during ownership.
For example, suppose you paid $150,000 for your home, had $3,000 of non-deductible closing costs at the time of purchase, spent $20,000 on remodeling project, deducted $2,000 depreciation for an office at home, and claimed a $4,000 casualty loss. Your adjusted cost basis is therefore $167,000. The $167,000 deducted from your $232,000 adjusted or net sale price produces a $65,000 sale profit.
For important tax questions it is advisable to seek the advice of a tax professional or CPA.