Can I prorate capital gains exclusion if I lived in a house for 4 years and then rented it for 3.5 years? Both my wife and I are listed as owners.

[isaac1]

My wife and I had to relocate in 2014 due to employment. We had planned on moving back so we choose to rent out our town house. It now looks like we will not be moving back so I would like to sell it but apparently capital gains tax exemption requires that it be a primary residence for 2 years in the last 5. We lived there for 4 years before moving and have been gone almost 3 years now. I would sell it now but I can't kick my renters out without a couple months notice.

I've heard that in some situations you can prorate the exemption especially in the case that a husband and wife lived their for a certain period of time. 

Someone also mentioned I might be able to do a 1031 exchange but I can't find information on whether I can sell and house and put the proceeds into a new primary residence which I what I need to do.

[TaxGuyBill]

Yes, if the primary reason for the move was due to a change in employment, you can use the exclusion, but the Maximum Exclusion will be prorated.

[SweetieJean]

"My wife and I had to relocate in 2014 due to employment"
Even if the move was back in 2014?

[TaxGuyBill]

Yes.  Although in the past I had thought it would not qualify, after re-reading the Regulations, it seems like the "Safe Harbor" of a change of employment overrides the other rules, so it still qualifies for the exclusion (with a prorated Maximum amount).

[achaparro41]

@TaxGuyBill please help! I'm interested in selling my rental house and wanted to see if the rules are still the same.
We bought a house in Austin, TX  in 2007. During the last five years we've rented the house, then lived in it for 18 months, got a new job in Los Angeles, CA, and by July will have been renting the house for three years.

If I sell the house, will I qualify for a pro-rated capital gains exemption?
Will I only need to pay the recapture depreciation tax?

Any insight would be much appreciated.

[TaxGuyBill]

If the house is sold within 3 years after you move out, yes, it will qualify for AN exclusion.  But NOT the full exclusion.  In your case, you will have TWO things to prorate.

One is of the maximum amount.  So you would qualify to exclude up to 18/24ths of $250,000 ($500,000 if Married Filing Jointly).  That is the situation of the original question on this thread.

But in your case, it is also prorated based on "Nonqualified Use".  To keep it simple and not get bogged down into the details, let's say (a) you owned it for 15 years, (b) it was you main home for 7 of those years, and (c) it was rented for 3 years AFTER you moved out for the LAST time, then you can only exclude 10/15ths of the gain (not including depreciation).  The 5 rental years BEFORE it was your Main Home this last 18 months can NOT be excluded.

So in that scenario, you would pay tax on 5/15ths of the gain, PLUS the depreciation.

[achaparro41]

Thank you for answering so quickly and helping navigate the situation @TaxGuyBill
Wouldn't moving to another state for a job override the other rules?

Here's the full picture.
Bought in 2007.
Lived for 3.5 years
Rental for 3 years
Lived for 18 months
Got a job in a different state
Rental for 3 years
Want to sell 🙂

The depreciation recapture tax would be for 6 years but I'm still unclear what the prorated percentage would be for capital gains.

[TaxGuyBill]

The job-related move overrides the requirement to have used it as you Main Home for the last 2 out of 5 years, but that doesn't change the other proration due to Nonqualified Use.

It looks like you will have owned it for 11 years.  The 3 rental years before the 18 months can NOT be excluded, so you will pay tax on 3/11ths of the profit (the actual calculation uses days, rather than years), plus depreciation.

So let's say you bought the home for $200,000, took $30,000 of depreciation, and sell it for $300,000.  In that scenario, you will owe long-term capital gains on $27,272  (3/11th of the $100,000 profit), plus tax on the $30,000 of depreciation (taxed at your regular tax bracket, up to 25%).

[achaparro41]

Thanks for the clarity @TaxGuyBill! Gives me a lot to consider but now thanks to you, I have a complete picture. Really appreciate it.

[Critter · Accepted solution]

1031 exchange is possible but only if you immediately buy another rental property and you use a third party facilitator. 

No matter what you do the depreciation will have to be recaptured but the capital gains may be reduced by getting a partial exclusion if you moved due to a work related situation.  The program will walk you thru the entire process when you indicate the rental was sold so follow the instructions slowly and carefully. 

[djfunk]

There are multiple CPA’s claiming that once you rent it out past the 3 year mark you cannot qualify for Pro rating of capital gains. Is this true?

what if you owned the house for 7 years, rented it for 3 years and it takes a month to sell which Results in you living in it for 23/24 months?

[Opus 17]

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@djfunk wrote:

There are multiple CPA’s claiming that once you rent it out past the 3 year mark you cannot qualify for Pro rating of capital gains. Is this true?

what if you owned the house for 7 years, rented it for 3 years and it takes a month to sell which Results in you living in it for 23/24 months?

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Your question here is not clear because you are leaving out facts from your other posts.

In general, if you do not qualify for one of the "safe harbors" in section 121.1-3, then renting more than 3 years ends the exclusion.  It's too long between the job change and the home sale to qualify, even though a job change in general is a reason for the partial exclusion.  

If you qualify for a safe harbor as defined in 121.1-3, then you can still use a pro-rated exclusion.  The safe harbor overrides the other objections. 

You have been adding on to old posts rather than start your own thread, so you have only presented a limited set of your own facts.  What you said was "What if you have owned the home for 10 years, lived in it for the first 7, relocated due to job and rented it out for 3 years and 2 months before selling, can you still get a pro rated exclusion?" 

So you talk about time but not distance.  The job change safe harbor specifies the following:

The qualified individual's new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment, or, if there was no former place of employment, the distance between the qualified individual's new place of employment and the residence sold or exchanged is at least 50 miles.

So if the home you are now trying to sell, is at least 50 miles farther away from your new job than it was from your old job, you meet the safe harbor rule and can use the partial exclusion.  

Having seen @TaxGuyBill here tell the person who started this thread say that they would qualify, then I will agree with him, even though I was doubtful on the other topic where you were posting. 

Incidentally, it's usually better to keep your conversation in one place, and post links to other related conversations, rather than keep multiple conversations going. 

[djfunk]

Thanks for the advice, I’m sorry that I did not  specify it was job out of state so yes it is more than 50 miles, I will start my own thread next time.

I was not sure if there was anybody still responding as the last response was in 2019, but the question was related to my situation.