Sign Up

Why sign in to the Community?

  • Submit a question
  • Check your notifications
or and start working on your taxes
cancel
Showing results for 
Search instead for 
Did you mean: 
msan4444
Returning Member

121 exclusion - convert to primary - IRS behavior?

Contemplating the sale of a home and wishing to minimize the resulting tax, my question centers on IRS behavior in a specific scenario. The home was used as a rental more than 5 years ago but after 2008. In the terminology of 121 cap gains exclusion, there was no non-qualified use in the 5 year look-back period. Pub. 523 in worksheet 3 instructs the taxpayer to bypass all calculation of a qualified use ratio when no period of non-qualified use exists in the 5 years prior to sale (section b, if you don’t know the verbiage then you aren’t likely the right subject matter expert for this question). So, getting to the question, what, in your experience, has been the IRS’  RESPONSE  when homeowners rent out their condo and then convert it to primary residence for 5+ years then, upon the sale of the condo, follow the p523 Wks3 SectionB instructions to take the full exclusion? I want to sell but I cannot un-sell the home if the exclusion is denied in examination so I would like SOME idea of past/recent IRS behavior here in order to make a considered decision.

11 Replies
martinmarks1919
Level 9

121 exclusion - convert to primary - IRS behavior?

I'm not sure the language you're referring to means what you might think it means. Click the link and scroll down to the bottom of the page. https://www.cpajournal.com/2020/02/05/how-the-loophole-in-irc-section-121-can-benefit-homeowners/

msan4444
Returning Member

121 exclusion - convert to primary - IRS behavior?

Hi, Thanks for replying but I don't think you are talking about publication 523.

 

I am referring to this:

 

Section B. Determine your non-qualified use gain. Complete this section only if there is a period, after the year 2008, when neither you nor your spouse (or your former spouse) used the property as a main home, and that period of non-use occurred during the 5-year period prior to the date of sale and before the time when you or your spouse (or your former spouse) used the property as a main home.* Otherwise, skip to Section C.

 

The circumstances I described, wherein there was only qualified use during the 5-year period prior to the date of sale, objectively results in skipping to section C.  I am inquiring as to outcomes when following this path.

martinmarks1919
Level 9

121 exclusion - convert to primary - IRS behavior?

I'm not sure if the instructions are poorly worded or what but you can't rely on ANYTHING in IRS publications because they're not authoritative. Here's a link....https://kb.drakesoftware.com/Site/Browse/14896/1040-Sale-of-Primary-Residence-Used-as-Rental

So, there's the rule and the exception and you're referring to one of the exceptions that states:

A period of non-qualified use doesn’t include

            1. Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home.

Seems apparent that you'd have non-qualified use for any period after 2008 if you moved into the home after it was being used as a rental but not if you converted it to rental use after using it as a main home.

 

msan4444
Returning Member

121 exclusion - convert to primary - IRS behavior?

Hi, thanks for replying.

 

It is hard for me to know the rulings, precedents and policies which may affect the IRS behavior. For all I know there are other things which might make the exact letter of the 2008 law lead to my misinterpretation. There are a lot of questions on Intuit forums about whether to believe pub 523 with MANY experts in disagreement over this scenario. As a layperson, I cannot resolve the experts' arguments. I just want to know what has actually happened when p523 wks3 sB is skipped as directed. That is, in this very specific case, are people being allowed to do what they're being told to do?

Have you any experience with the behavior of the IRS when taxpayers follow the worksheet in pub 523 and thus skip section B?

msan4444
Returning Member

121 exclusion - convert to primary - IRS behavior?

Also, if anyone has experience but does not wish to discuss it in a public forum then just post something letting me know to contact you privately. Thank you.

martinmarks1919
Level 9

121 exclusion - convert to primary - IRS behavior?

Have you any experience with the behavior of the IRS when taxpayers follow the worksheet in pub 523 and thus skip section B?

The only way ANYONE is going to have any experience with that would be if they or the taxpayer they represented had been audited.....the IRS would never know whether there was a period of  non-qualified use otherwise and they're not going to put past returns together to figure it out.

If a taxpayer wants to try and omit the Section B even though it states......Enter the total number of days after 2008 when neither you nor your spouse (or former spouse) used the home as a main residence. This number is your non-use days......and it's clear from the law that the one exception applies only if the non-qualified use is after use as a main home then have at it. That taxpayer should remember that they won't be able to rely on any language in Pub 523 to avoid an assessment if audited.

 

msan4444
Returning Member

121 exclusion - convert to primary - IRS behavior?

Thanks Martin for your comment regarding experience. It is that sort of experience I'd like to hear about. Based on your point (that people who do not get audited do not have a confirmed experience of the sort described) then I guess the absence of experienced responses may suggest an absence of audits (not that that is at all a reliable metric).

 

Somebody must have followed the instructions!  What happened?!?  What didn't happen?

 

Btw, your reference to "Enter the total number of days..." is contained within the section that the IRS says not to complete when you have used the property as a main home for the last five years. The publication says DO NOT enter the days at all and instead skip to section C. 

 

I hear clearly that you are one of the people who believe the publication is presenting a mistaken test for skipping. I am not qualified to disagree (or, for that matter, agree). If you would like to see experts disagree you can check out these intuit questions:

https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/capital-gains-from-th...

https://ttlc.intuit.com/community/taxes/discussion/selling-primary-residence-that-was-initially-a-va...

 

However, argue about that in THOSE threads. This one is about IRS behavior.

 

My lay takeaway from those threads, fwiw,  is the "Experts" say you can follow pub523, skip B and take the full exclusion (excepting of course depreciation recovery) while those without "Expert" in their profile say something to the effect that the law disagrees with pub523 and nothing can possibly have changed how the law is interpreted since it was enacted in 2008. A more trusting person would see the experts lining up on just one side of this and do their taxes accordingly. I, perhaps sadly, look before I leap and thus would like to know how these things actually turn out.

martinmarks1919
Level 9

121 exclusion - convert to primary - IRS behavior?

However, argue about that in THOSE threads. This one is about IRS behavior.

I have no desire to argue this issue at any further length but you should take note that the publications can be and have been wrong in the past.....caveat emptor.....and you should note WHO LOSES when there is a dispute between the IRS and the taxpayer over language in the publications versus statutory language......guess which? Also, IRS behavior is whatever they want it to be.....they'll leave some returns alone while pursuing others forever and there's no such thing as "selective prosecution" for them. Do you want to play the audit lottery?

 

 

FWIW, I prefer @AmeliesUncle's response in the thread cited by you over the "experts":

 

I am aware that the IRS screwed up the verbiage in Publication 523 a few years ago, but the law did not  change, and the law is clear about it.

 

The term “period of nonqualified use” means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse.

 

 

I think the author who revised Publication 523 was TRYING to explain one of the exceptions, but failed miserably.

 

Mike9241
Level 15

121 exclusion - convert to primary - IRS behavior?

if you took or should have taken depreciation on property that is now fully qualified for the full 121 exclusion, you still have to recapture the depreciation but not in excess of the gain 

Hal_Al
Level 15

121 exclusion - convert to primary - IRS behavior?

You may NOT take a full exclusion on the gain.

 

First,  you must recapture (pay tax on) the depreciation "allowed or allowable" (claimed or shoulda been claimed).  Second,  you must prorate the other gain between rental time (non qualified use) and principal residence time (qualified use)*.

When you enter the home sale in Turbotax (TT), and follow the interview carefully, TT completes the "Home sale work sheet" to handle that complex calculation of the partial home sale exclusion, non qualified (rental) use capital gain and depreciation recapture.

 

*A period of nonqualified use does not include: Any portion of the 5-year period ending on the date of the sale or exchange AFTER the last date you (or your spouse) use the property as a main home.   That does not appear to be your situation. 

 

 

 

Rick19744
Level 11

121 exclusion - convert to primary - IRS behavior?

I agree with @Hal_Al in that your attempt in reading and quoting a portion of worksheet 3 are not your facts.

The IRS, in general, do a pretty good job at explaining the code and regulations in the publications.  However, when the situations get complicated, as is this one, sometimes they are not the model of clarity, but that is their attempt at trying to put into english, Treasury code and regulations and technicalities within the language of each.

The section you are reading is saying that if there was some non qualified use during your last 5 years of ownership beginning AFTER the last date this was considered your principal residence, that time would not be considered non qualified.

By way of example, if you used the home as your principal residence beginning 1/1/ 2014 up until 1/1/2019, moved out and sold it in 2020, 2019 and 2020 would not be considered non qualified use even though you were not using it as your principal residence.

As to your main overriding question on IRS "behavior" if something in a publication may be confusing or misunderstood and you followed what you believe to be accurate based on the publication, you will not prevail if audited, if you go to IRS Appeals, if you go to Tax Court or some other Court.  You may not be subject to any penalty, but you will still owe any tax and interest.

*A reminder that posts in a forum such as this do not constitute tax advice.*
Dynamic AdsDynamic Ads
Privacy Settings
v