Not under federal law. Under federal law, if you added your son to the deed to make him an owner, and then he lived in it as his primary residence for two years, he would qualify for the capital gains exclusion on his primary residence. However, the exclusion is modified by something called a period of non-qualified use. This is somewhat difficult to explain in brief language, and the IRS does not even cover it in the current version of publication 523 on the sale of your home. (The calculation for nonqualified use is included in the worksheets, but there is no description of what it means.)
Basically, the non-qualified period rule means that you cannot convert the taxable sale of a rental property into non-taxable sale of personal property simply by moving into it for two years. If this was a rental property for seven years and a personal residence for two years, then seven years are non-qualified and two years are qualified. When your son sold the home, he would be able to apply 2/9th of the capital gains to the personal exclusion, but the other 7/9th of the capital gains would still be taxable. If your son lived in the home for five years before selling it, then 7/12 would be non-qualified and 5/12 would be qualified. And so on. Because the home would be a gift from you to your son, his adjusted cost basis for determining his capital gain would be the current depreciated basis after being a rental for seven years.
In addition, the depreciation recapture must always be paid, no matter who lives in the home and for how long.
The only sure way for your son not to owe any capital gains tax when selling the home is to inherited after you died, because he would receive a stepped up basis.
I suggest you see a financial planner for advice on any strategies that might reduce the tax owed. And I don’t know about Michigan law. But under federal law, whenever that home is sold, the seller will have to pay the depreciation recapture and capital gains on the appreciation that occurred during the period of time that it was a rental.
