House Sale: What Happens If I Don't Meet 2 of 5 yr Residency

Forum|Forum|7 years ago
June 1, 2019
2 replies
14 views

I have owned a home for the last 5+ yrs, living in it for 3 yrs and renting it for the last 2+ yrs.  We have listed it for sale, but if it doesn't sell soon, we will no longer meet the "2 of 5 yrs" rule that allows complete exception of capital gains tax.

Is the tax that we owe pro-rated if we go over the 2 of 5 rule?  Or does this go from not-owing the tax to owing 100% of the tax?

I've read IRS 523, but it's super confusing.  If I moved for work 2.5 yrs ago, do I qualify for a partial exception?

(This is driving me nuts because I will likely net +$160k on the sale)

TurboTax Premier Online

Carl

Level 11

The bottom line is this. To qualify for the capital gains exception, you must have lived in it for 2 of the last five years, counting backwards from the closing date on the HUD-1 statement you will receive at the closing when you sell it. What you can do is select the option for 2 of last 5. The program will ask you for days lived in, in the last 1826 days prior to the closing date. If you qualify for exceptions that allow pro-rating, the program will know "BASED ON THE DATA YOU PHYSICALY ENTER". If you don't qualify, you don't qualify.

There are exceptions for active duty military who are moved under orders. But those exceptions allow for extension of the 5 year rule, and not for a reduction of the two year rule.

TaxGuyBill

Level 13

You probably owe 100% of the tax.

There is a provision that if the "primary reason" for the sale was because of a job change you could qualify for a partial exclusion. However, because you HAD already met the 2 year period, the job change isn't really why you didn't meet the two year rule. The fact that your rented it for 2+ years indicates that the job change was not the "primary reason" for the sale.

Chris981

Level 2

Not sure if the guidance has changed but doesn't the IRS presume you sold by reason of home move

If a safe harbor described in this section applies, a sale or exchange is deemed to be by reason of a change in place of employment, health, or unforeseen circumstances.

There is a bulletin from 2004 that gives further commentary that says whatever the rational for the sale, if the homeowner meets these safe harbor qualifiers they won't be challenged. I think the original poster would qualify. There are no automatic dis-qualifiers such as renting the home that I can find.

nternal Revenue Bulletin: 2004-39 | Internal Revenue Service (irs.gov)

One commentator asserted that the factors are beyond Congressional intent, unnecessary, and overbroad. The final regulations retain the list of factors because it is helpful in determining the taxpayer’s primary reason for the sale or exchange.

For each of the three grounds for claiming a reduced maximum exclusion, the temporary regulations provide a general definition and one or more safe harbors. Under the temporary regulations, if a safe harbor applies, the taxpayer’s “primary reason” for the sale or exchange is deemed to be change in place of employment, health, or unforeseen circumstances.

Opus 17

Level 15

You will owe tax on the capital gains, which is not the same as the cash you get out.

Your capital gains is the difference between the adjusted cost basis and the net selling price.

The net selling price is the actual selling price minus transfer taxes, other legal fees, real estate commission, and buyer's closing costs if you pay them. (Minor pre-sale repairs and staging costs don't count, unfortunately.)

The adjusted cost basis is the price you paid, plus certain closing costs that were part of the original purchase, plus the cost of any permanent improvements you made to the property over the years, and minus any depreciation you took or could have taken when you were renting it out, and minus any casualty loss you may have claimed.

The depreciation recapture is taxed at 25% and the rest of the gain is taxed at the 15% rate for long term capital gains (for most taxpayers).

Considering the tax cost of selling after the deadline, you might want to drop your listing price to get an earlier sale, or offer to pay closing costs. Ask your real estate agent how to get a quicker sale with this in mind.