Publication 523 - Exclusion on Capital Gain

[dsv2kx]

I sold a rental property in December 2019 which qualified for full capital gain tax exclusion due to 2 out of 5 year primary residency rule and took the exclusion on the tax returns we filed earlier this year for 2019.

Prior to the sale of our rental property, we bought a house in November 2017 which was and still is our primary residence.

We are thinking about selling our primary residence, but want to make sure that it will qualify for the full tax exclusion benefit (not partial) under Publication 523. At what point can we sell to qualify for full exemption?

Publication 523 states the following:
Eligibility Step 4—Look-Back

Determine whether you meet the look-back requirement.
If you didn't sell another home during the 2-year period before the date of sale (or, if you did sell another home during this period, but didn't take an exclusion of the gain earned from it), you meet the look-back requirement. You may take the exclusion only once during a 2-year period.

So with that being said, do we have to wait until December 2021 to sell our primary residence since we sold our rental property December 2019 and take the Tax exclusion in 2022?

OR

Can we sell our primary residence as early as January 2021 and take the tax exclusion in 2022 which would meet the rule that we can take the exclusion once during a 2 year period, but the interval between the sale of our rental property (Dec 2019) and primary residence (Jan 2021) is less than 2 years?

[tagteam · Accepted solution]

I hesitated to reply because I believe you understand the issue fully; you can only take the exclusion once in any 2-year period. That part of the rule is fairly simple and straightforward.

[Carl]

At what point can we sell to qualify for full exemption?

An absolute minimum of 731 days after your closing date on the last sale you took the exclusion on. One day early and you don't qualify.

Additionally, the property "MUST" have been your primary residence for an absolute minimum of every single day of those 731 days too. One day short and you don't qualify.

Now I count days. But the IRS counts differently. If the house was your primary residence from the 1st to the 15th of the month, then that month does not count at all. Whereas if it was y our residence from the 1st to the 16th of the month, then the entire month counts. For me, I would suggest you use a day count and add 30 days to it to account for the 16 day requirement on each side of the middle of the month. Then you can't possibly miss.

Example:

Property from last sale was your primary residence at the time of the sale and you closed on the 16th of the month. Your count for the next house starts on the 1st day of the next month. It's like you just "lose" the days from the 17th (day after closing) to the end of the month.)

[tagteam]

It is 730 days @Carl 

See Treas. Reg.  § 1.121-1(c)(1)

[Carl]

Not in a leap year, such as is 2020.

When doing the lookback, you're guaranteed to cross at least 1 leap year. When looking at the "2 years" part of the 5 year look back, it can matter if it crosses a leap year.

Overall though it really doesn't matter because of the convoluted way the IRS does the math, where if it was your primary residence from the 1st to the 16th, you get to count the entire month. Sucks for February since mathimatically, the 15th day of that month is past the halfway point.

[tagteam]

Here is what I have got per the treasury regulation I cited @Carl :

The requirements of ownership and use for periods aggregating 2 years or more may be satisfied by establishing ownership and use for 24 full months or for 730 days (365 × 2). 

Note that this Reg states nothing about the "1st to the 16th" or leap years. In fact, it states "24 full months" OR "730 days". If you have a cite to support your proposition, then go ahead and post it here.