Sale of a rental after unusual circumstances

[ELKIV]

Our family relocated to Georgia due to a job change in 2008 at which time we purchased a primary residence based on the anticipated closing of our other primary residence in Florida, which was under contract.  The Florida sale never closed and we were forced to rent the property.  After two years, we determined that we could no longer afford the Georgia house we were in without the expected proceeds from the FL sale and so we listed the GA house.  After two more years without a single offer we were desperate and moved to another significantly more affordable home and began renting the house we purchased in 2008.  The rent covered the mortgages for the most part but from 2008-2012 I had drained my retirement savings trying to keep us afloat.  I finally sold the 2008 Georgia house in 2017.  So now I'm doing my taxes and we haven't lived in the house since spring of 2012... 5 years.  So after depreciation I'm getting hit with a huge "gain" on the house, even though in reality, after real estate commissions, I basically broke even.  The program asks about if my wife or I had lived in the house for 24 months in the past five years.  We didn't, but the program mentions that some exceptions are allowed in extenuating circumstances but Turbo Tax doesn't really show you how to take advantage of that... and I'm not sure if my situation qualifies.  Can someone direct me on what to do?

[PaulaM]

See the following exception listed in the IRS publication 523:

Eligibility Step 5—Exceptions to the Eligibility Test

There are some exceptions to the Eligibility Test. If any of the following situations are true for you, read on to see if they may affect your qualification. If none of these situations apply, skip to Step 6.

• A separation or divorce occurred during the ownership of the home. See Separated or divorced taxpayers .

• The death of a spouse occurred during the ownership of the home. See Widowed taxpayers .

• The sale involved vacant land. See Vacant land next to home .

• You owned a remainder interest, meaning the right to own a home in the future, and you sold that right. See Remainder interest .

• Your previous home was destroyed or condemned. See Home destroyed or condemned—considerations for benefits .

• You were a service member during the ownership of the home. See Service, Intelligence, and Peace Corps personnel .

• You acquired or are relinquishing the home in a like-kind exchange. See Like-Kind/1031 exchange .

IRS Pub 523

[LindaA]

Yours is a complicated situation. At first glance, it doesn't seem you would even qualify for a reduced exclusion (i.e., a fraction of the maximum $500,000 of gain exclusion for a married couple filing jointly). The IRS permits partial exclusions for certain events, but nothing listed in IRS Pub 523: Selling Your Home applies to your situation. IRS will consider "Other Facts and Circumstances", which sounds promising until you plug your numbers into Worksheet 1: Find Your Exclusion Limit.  Step 1 asks you to determine the shortest of three periods, which for you and your wife would be 0 (the time of residence in the home during the 5-year period leading up to the sale). Since the exclusion amount is multiplied by this value, your exclusion will be zero. Pub 523 also says that space used as a rental can be treated as residential space if you meet certain criteria, but from what you've told me you do not. Again, yours is a complicated scenario (and one I have not experienced firsthand), so I am going to ask a colleague for additional insight. I'll get back to you soon with my findings. 

[LindaA]

Consider filing an extension so you can get additional guidance for your situation before finalizing your tax return. Keep in mind that it is an extension of time to file your return and not an extension of time to pay your tax bill, so you should include payment (at least as much as you can) with the extension. (The IRS won't charge you a late filing fee if you file an extension, but interest will accrue on your balance due.) Then you can contact a tax attorney who specializes in real estate transactions to see if there is anything that can be done to ease your tax burden.

For more information, please see Filing an Income Tax Extension.