Can I prorate capital gains if we lived in a place for less than 2 years, rented for 4 years? We converted it into rental property when I was transferred by my company to the US.

[jaxolist]

Like the title suggested, here's a timeline of our property:

Bought and lived from Oct/2015 till Jul/2017;

Transferred to the US by my company in Jul/2017;

Rented from Sep/2017 till May/2021;

Sold in Jul/2021.

This property was owned by me and my wife together, and we have owned and used it as our primary residence for roughly a year in the past 5 years from selling date. We never used it as rental property before using it as primary residence.

The reason for selling is because of my job relocation & change in immigration status, when early this year it looks like I won't be kicked out of the country by the time my visa expires next year (before this I was working on a working visa that expires in 5 years and cannot be extended).

I thought the period of renting out would not count as non-qualified use, and the sale would qualify for the safe harbor as discussed in some other posts. Consequently, it would qualify us for roughly half the maximum exclusion amount, sine there was 1 year of primary residence in the past 5 years by me and my wife. But thought I would like to check with the forum if my understanding is correct for my circumstances. Thank you for your help!

[Hal_Al]

Based on court decisions, no partial exclusion for selling for health, change of employment or unforeseen circumstances would be available if the sale is more than 3 years from the time you moved out.

[AmeliesUncle]

I have have asked you this before, what WHAT court decisions?  From what I read, the Regulation clearly says that it DOES qualify for the Reduced Maximum Exclusion.

[Hal_Al]

 I'm quoting Champ @Mike9241 and am not interpreting the regs myself.  Reference: 

 https://ttlc.intuit.com/community/state-taxes/discussion/re-i-lived-in-my-primary-home-ca-from-10-20...

That said, it doesn't make sense that somebody who meets the 2 year rule loses the exclusion because they waited too long to sell, but somebody with an exception to the 2 year gets the exclusion.  Surely, there's been tax court cases on the issue.   Yes, I know there's lots of stuff in the tax code that doesn't make sense.

[Anonymous_]

@AmeliesUncle 

I have no idea where the "3 year rule" came from (I certainly cannot find reference to that time period anywhere, like you), but the following does appear in the regulations.

§ 1.121-3(b)(6):

The circumstances giving rise to the sale or exchange occur during the period of the taxpayer's ownership and use of the property as the taxpayer's principal residence.

Since @jaxolist was using the property as a rental at the time the circumstances changed (and not as a principal residence), it would appear as if the Section 121 exclusion would not apply.

[jaxolist2]

I thought the circumstance change (job relocation) happened when I was living there, so that would enable us to qualify for it. Are you referring to the immigration status? I mean we haven't changed our immigration status yet, it's just there's some progress which reduced our probability of not being able to stay. By that I suppose it should not count as a circumstance change itself.

* I was locked out of my account so registered a new one.*

[Anonymous_]

@jaxolist2 

I understand that the circumstances may have changed while you were using the property as your principal residence but, rather than attempt to sell the property, you made the decision to convert it to rental use (which could be determinative as to whether or not you would qualify for a partial exclusion).

[Carl]

would be available if the sale is more than 3 years from the time you moved out.

I've looked all over and can't find anything anywhere (IRS website or otherwise) that states or even insinuates that.  The closest I can find is where AD/MIL can suspend the day count for the "2 of last 5" for a maximum of 10 years if they are moved on official orders.

[jaxolist2]

Thank you for your response.

Just to confirm my understanding is correct: are you saying that prorated maximum reduction is not available to us, because IRS never mentioned anything it will be after we move out more than 3 years?

[AmeliesUncle]

---

@Anonymous_ wrote:

I understand that the circumstances may have changed while you were using the property as your principal residence but, rather than attempt to sell the property, you made the decision to convert it to rental use (which could be determinative as to whether or not you would qualify for a partial exclusion).

---

As was pointed out, the circumstances (job relocation) changed while he lived there.

If a person meets one of the "safe harbors" in the Reg, the Regulation shows no requirement for the sale to happen shortly after the circumstances.  It is only when they do NOT meet one of the "safe harbors" that the sale must be "proximate in time" in order to qualify for the Reduced Maximum Exclusion.

[Anonymous_]

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@AmeliesUncle wrote:

As was pointed out, the circumstances (job relocation) changed while he lived there.

---

I agree that the applicable Reg does not specify that the sale must occur shortly after the circumstances change. 

Frankly, I am still preoccupied with these purported "court decisions" that specify some sort of time constraint.

[Carl]

I am still preoccupied with these purported "court decisions" that specify some sort of time constraint.

I've looked for something pertaining to that off and on for the last 2-3 days now and also find nothing.

I think what they may be alluding to is this:

If the closing date on the sale is in fact, more than three years after the property was no longer your primary residence, then there's no way to meet the base requirement of it being your primary residence for 2 of the last 5 years you owned it, counting back from the date of the sale.

[Anonymous_]

---

@Carl wrote:

I am still preoccupied with these purported "court decisions" that specify some sort of time constraint.

I've looked for something pertaining to that off and on for the last 2-3 days now and also find nothing.

I think what they may be alluding to is this:

If the closing date on the sale is in fact, more than three years after the property was no longer your primary residence, then there's no way to meet the base requirement of it being your primary residence for 2 of the last 5 years you owned it, counting back from the date of the sale.

---

Whether they are alluding to "court decisions" or not, the fact of the matter is that the safe harbors in the applicable Reg has no requirement for the sale to happen shortly after the circumstances, as @AmeliesUncle stated in an earlier post, which would indicate that the taxpayer could qualify for a partial exclusion.

If a court decision has interpreted the Code and Reg otherwise, I would certainly appreciate a cite to that decision. 

[note that, quite obviously, if on the closing date of the sale more than three years have passed since the taxpayer has used the property as a principal residence, the typical taxpayer will not qualify for the full exclusion - and the full exclusion is not at issue here]

[jaxolist2]

Thank you all @AmeliesUncle @Carl @Anonymous_ for your input and discussion. The situation regarding our case is much clearer to me now.

If I may summarize the key points that enable us to have the prorated maximum reduction:

- Circumstance change (job relocation) happens when I used it as our primary residence, and as such, converting it to rental property does not disqualify us.

- Distance safe harbor supersedes the requirement of time approximation between circumstance change & sale, which we will certainly qualify due to international relocation.

Consequently, as this property was owned and used as primary residence by me and my wife for approximately a year in the last 5 years, we are entitled to have roughly half the combined maximum exclusion, i.e., ~ 250K.

Thanks again for all the help!

*Unfortunately I was locked out of original account and cannot find my password, so can't vote any of the answers as adopted.*

[Anonymous_]

@jaxolist2 

I do not believe it has been mentioned in this thread, but recall that any Section 1250 unrecaptured gain (as a result of depreciation during the rental period) has to be factored into the equation.