There are three common examples of nonrecognition property transactions under U.S. tax law. Those fancy words simply mean that the law may allow you to avoid recognizing gains on a property transaction if certain conditions are met.
The most common example — and the one you’re most likely to encounter if you move to Portugal and sell your primary home in the U.S. to buy your own home here — is called theSection 121 exclusion. This provision allows an individual taxpayer to exclude up to $250,000 of gains from the sale of their home, or up to $500,000 for a married couple.
If you qualify for this exclusion, it is generally not necessary to report the sale to the IRS, although disclosure is always advisable. If part of the gain remains taxable, the sale must be reported on Form 8949.
To qualify, two main requirements must be met. First, the property must have been your primary residence. Second, you must pass the ownership and use test, which can be a little tricky. You must have owned and lived in the property for at least two years. This requirement can be satisfied by either 24 full months of ownership and use or 730 days within a five-year period.
There are a few exceptions, but this is the general idea behind the Section 121 exclusion for the sale of a home.
Portugal has a somewhat similar provision allowing nonrecognition of gains on the sale of a main home, but the rules are much stricter.
In Portugal, you can qualify for this exclusion only if the proceeds from the sale are used to purchase or improve another property located in Portugal or elsewhere in the European Union. The new property must be used exclusively as your primary residence.
The reinvestment must take place within 24 months before the sale or within 36 months after it. You must declare this on your tax return - even if you have not yet used the proceeds but intend to within the allowed timeframe.
If the reinvestment does not happen within this period, or if the new property is not designated as your main residence, the gains will be taxed as if the property were an investment property.
Additionally, the exemption can also apply if the proceeds are reinvested in certain life insurance or capitalization products in Portugal or elsewhere in the European Union.
Here is a practical example of how things can get complicated:
Imagine a taxpayer who leaves the U.S., becomes a tax resident in Portugal, and after one year finds the perfect home in Portugal to settle in. They sell their property in the U.S., apply the Section 121 exclusion, and pay no U.S. tax on the gain. However, because the home was not located in Portugal, the Portuguese exclusion does not apply. As a tax resident, they must report worldwide income. This means the sale of their U.S. property will generally be subject to taxation in Portugal unless they qualify under the NHR or TISRI (NHR 2.0) tax regimes, which offer exemptions for this type of income.
In such cases, only 50% of the gain is taxable. Instead of a flat rate of 28%, the gain will be added to your taxable income and taxed at progressive rates, which can go up to 48%.
In short, both jurisdictions offer exclusions for gains on the sale of a primary residence. For those who are already or planning to become tax residents in Portugal and who want to delay selling their U.S. home, it may be worth exploring eligibility under the TISRI (NHR 2.0) regime to override the Portuguese rules and preserve the benefits of the Section 121 exclusion.
