What Is Primary Residence and How It Can Save Your Tax?

Your primary residence plays a vital role in both your finances and your life. You usually have to own and live in your primary residence.

A primary home matters for you and has its importance. A primary residence:

• Affects your mortgage rates.
• Determines the tax benefits you are eligible for.
• Is your residence listed on all legal documents.

Primary Residence Definition

Primary residence (also known as a principal residence) is a property you own and live for most of the year. You can only have one primary home at a time.

However, merely owning a property doesn’t automatically classify it as your primary house. The Internal Revenue Service (IRS) has specific rules to help you determine if your home qualifies as one.

A primary home can get you deductions on mortgage interest rates. It also allows you to exclude profits from capital gains tax. 

How Do You Prove You Live in Your Primary Residence?

There are multiple ways to prove that you live in a primary residence. You can prove it through:

• Tax returns
• Utility bills
• Voter registration card
• Motor vehicle registration
• Address near your workplace
• Address on your driving license

What Qualifies as a Principal Residence?

The owner shouldn’t have sold another property using a primary home tax exemption in the last two years. Additionally, the owner must follow the 2 out of 5 year rule.

This could include a house, apartment, condominium, or any other type of property where you reside on a regular basis.

What Is the 2 Out of 5 Year Rule?

This means you must have owned and lived in the home for at least two out of the last five years. 

These two years don’t have to be in a row. It’s a total of two years or 730 days within a five-year period. This rule also extends to married couples who file their taxes together.

Benefits of a Primary Home

The benefits of labeling a property as your primary residence are:

1. Tax Benefits: Mortgage interest and property taxes on a primary house are lower than other properties. The exact decrease in amount depends upon factors such as location, property value, and local tax rates.

2. Homestead Exemptions: Primary residence allows homeowners to protect a certain amount of the equity in their primary residence from creditors’ claims. The exemption amount varies from state to state.

3. Retirement Planning Perks: You can potentially free up funds to support your retirement by taking advantage of the capital gains exclusion.

4. Government Program Benefits: This includes first-time homebuyer assistance, flood insurance assistance, property rehabilitation programs, etc.

Capital Gains on a Primary Residence

Capital gains on a primary residence are the profits from selling it above its buying cost. It is calculated by subtracting the home’s purchase price from its final sale price.

Primary homeowners enjoy tax advantages related to these gains. Typically, you don’t need to pay tax on a specific portion of your capital gain if you sell your primary home.

A single owner can exclude up to $250,000 in capital gains. That’s huge! On the other hand, if you’re married and filing taxes jointly, you can exclude up to $500,000

Can You Do a 1031 Exchange on a Primary Residence?

No, you typically cannot do a 1031 exchange on primary residences. A 1031 exchange (or a like-kind exchange) is a tax-deferral strategy that allows you to swap investment properties.

If homeowners turn their home into investment property and sell within five years, they can’t use the 1031 exchange. They also don’t get any capital gains tax exclusion.

How Does the IRS Check Primary Residence?

The IRS declares your home as your primary residence if:

• You live in the property for most of the year.
• You live there as your primary home for at least a year after buying it.
• It is your official address for USPS, driver’s license, taxes, and voter registration card.
• Your bank accounts, credit card statements, and loan agreements contain the same address.

Primary Residence vs. Secondary Residence

Primary Residence	Secondary Residence
It’s the main property where you live most of the year.	It’s a vacation home away from your primary home.
A primary home buyer easily gets the mortgage at a comparably lower interest rate.	Mortgage rates might be a bit higher than primary homes.
You must live at least two years out of the last five years in a property to claim it as your primary house.	You might need to stay there for some time to rent it out.

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