Investors & landlords

Opus 17 · ‎March 1, 2021

@sk4000sk2 wrote:

Thank you so much. This is great support. So, I gather that spending 731 days each in both homes and having a combined gain of less than 500K will not qualify my wife and I for exclusion on both homes.

The exclusion is per transaction, and you can't use the exclusion more than once every 2 years (731 days). You can't say, "I'll use half my exclusion on this house and half on the other house."

And it's not just "spending" 731 days in the home, it has to be your residence.

And, to use the $500,000 exclusion, both you and you wife have to separately meet the 2 year residency test.

There may be a rule to use the exclusion on both properties, if spouse 1 uses their solo exclusion on home A and spouse 2 uses their solo exclusion on home B.

Part 1

I will start by assuming you sold house A on Feb 28, 2021. The 5 year lookback takes us to Feb 28, 2016. I will assume you moved out on December 15, 2016. That's 291 days. Next I will assume you moved back into house A to renovate it and lived there from November 1, 2019 until the closing on Feb 28, 2021. That's 459 days, total 750 days. You qualify to use the exclusion on house A.

But you actually had to live in house A for that time -- clothes, bed, cooking food in the kitchen, etc. It has to be your principal residence, as that word is usually understood. You only have one principle residence at a time. If you were living in A over the weeks and B over the weekend, only 1 of those is your principal residence and the other is temporary. If you lived in A 5 days a week and B 2 days a week, A is probably your principal residence 7 days a week and the weekends are "temporary absences." But if you are still getting all your mail at B and doing your laundry at B on the weekends, it may be more the case that B is your principal residence the entire time and A is temporary.

Now, regarding B, I will assume you lived in B from December 15, 2016, until November 1, 2019. You meet the residency test for home B, and could also use the exclusion on B.

Part 2

Here's where things get dodgy.

Possibly, if the two spouses file separate returns for 2021 (married filing separately), then spouse 1 can report the sale of home A and claim the single exclusion of $250,000, and spouse 2 can report the sale of home B and use the single exclusion of $250,000.

Exception: if you live in a community property state, this strategy would not be allowed under state law.

I know that this strategy would work if both spouses did not meet the residency requirement (for Example, if spouse 2 did not move back to home A during the renovations, then spouse 2 does not meet the residency rule. Spouse 1 can claim the reduced exclusion of $250,000. (It's $250,000 per person, or $500,000 if married filing jointly as long as both spouses meet the residency rule.)

I am less confident that this strategy would work if both spouses meet the residency requirement for both homes, I can't tell from the instructions and tax code whether the exclusion can be split in this way.

I think that separate returns are required due to a particular sentence in the tax code, but you will want to have this entire situation reviewed by an accountant anyway.

Important

And of course, the spouses actually have to have moved back to house 1 as the principal residence, and not just be claiming it for sham purposes. The point of the exclusion is to give people a tax break for the home where they live as their main home, and not give them a tax break on homes used for investment.

Part 3

And finally, in the situation where you move out of home 1, rent it for a while, move back into home 1, and then sell it, you can't exclude all your gain due to the "qualified use" rule. This rule is hard to explain, although Turbotax include the calculation. Basically the rule is there to prevent investors from making all the capital gains on their rental property tax-free by moving into the property for the last 2 years before selling. In the case of house A, the qualified use rule means that 20% of your capital gain is not eligible for the exclusion at all.

So for house A, let's imagine you purchased the home for $150,000 and sold it for $300,000. For the 2-1/2 years as a rental, you did or could have taken about $10,000 of depreciation. That means your overall capital gain is $160,000. The first $10,000 is taxed as recapture; the next $30,000 is not eligible for the exclusion and is taxed as long term capital gains, and the final $120,000 is eligible for the exclusion if you meet the residency rule.

Conclusion

You may want to have the situation reviewed by a competent accountant, a CPA or enrolled agent, and not a seasonal storefront tax preparer.

You might be able to use the exclusion for both homes if you moved back into home A as your bona fide principal residence after the renter moved out.
Since the exclusion is per transaction, you can only do this if spouse 1 takes the $250,000 solo exclusion on home A (or B) and spouse 2 take the $250,000 solo exclusion on the other home.
You will always pay some tax on home A due to depreciation recapture and the "non-qualified use" rule.
Your ability to report the sales separately and take 2 exclusions may be affected by whether you file. joint return and whether you live in a community property state. This should be reviewed professionally.
If the gain on one or the other home is more than $250,000, you may still be better off claiming the full exclusion on one home and paying the tax on the other.

If you did not move back into home A as your bona fide principal residence, then only home B qualifies for the exclusion and everything else I wrote is worthless.