Capital gains from the sale of primary residence

[maxwang]

I rented the house i purchased for two years, then I moved in as my primary residence. If I live in the house for more than 5 years, say 6 years. When I sell the house, do I still need to prorate the capital gain based on the ratio of "rental time" to "owner time", or can I receive full exclusion ($50,0000)?

I asked this because in Section B, it is stated "...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.* 

In my situation, the rental time did not happen within the 5-year period prior to sale.

[DianeC958]

Yes, if you live in the house for 6 years you can claim the full exclusion for any gain you have when you sell the house.  The exclusions is up to $250,000 if you are filing as Single or $500,000 if you are filing as Married Filing Joint.

Tax Aspects of Home Ownership: Selling a Home

[AmeliesUncle]

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@maxwang wrote:

I rented the house i purchased for two years, then I moved in as my primary residence.

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No, you can't exclude all of the gain.  It will be prorated based on the amount of time it was your Principal Residence compared to the total time that you owned it.

So if you owned it for 8 years and use it as your Principal Residence for 6 years, you can exclude 6/8ths of the profit.  You will have a taxable gain on the other 2/8ths, plus tax on the gain due to depreciation (the actual calculation uses days).

[Edited for clarity]

[maxwang]

thanks for your reply, from the link you provided, I can't find the statement that fits exactly to my scenario. Just to confirm: as long as l live in the house for more than 5 years, I can obtain the Full exclusion? @DianeC958 

[AmeliesUncle]

You may not have seen my response yet, but NO, you can't exclude the entire gain.

[maxwang]

@AmeliesUncle  thanks for your reply. I understand the general rule to calculate the ratio,but how does the "Worksheet 3 Section B" affect the calculation " 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. "

In your example, if I live there for 6 years, the 2-year rental is out of the 5 year period.

[ColeenD3]

The gain seems to be excludable. You must have both owned and lived in the house as your main home for two of the five years prior to sale. Your dates of ownership and residence are not clear.

 You said, "In my situation, the rental time did not happen within the 5-year period prior to sale."

However, as Amelie's Uncle noted, any portion of the gain that is attributable to depreciation recapture is not included in the exclusion.

If you meet the qualifications to use the exclusion, any gain over that amount is a capital gain. The exclusions are $250,000 for single, and $500,000 for married filing jointly. See the rules below.

Does Your Home Sale Qualify for Maximum Exclusion

The tax code recognizes the importance of home ownership by providing certain tax breaks when you sell your home. To qualify for these breaks, your home must meet the Eligibility Test .

How your sale qualifies.   Your sale qualifies for exclusion of $250,000 gain ($500,000 if married filing jointly) if all of the following requirements are met.

• You owned the home and used it as your main home during at least 2 of the last 5 years before the date of sale.
• You didn’t acquire the home through a like-kind exchange (also known as a 1031 exchange), during the past 5 years.
• You didn’t claim any exclusion for the sale of a home that occurred during a 2-year period ending on the date of the sale of the home, the gain from which you now want to exclude.

[AmeliesUncle]

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.

(ii)ExceptionsThe term “period of nonqualified use” does not include—

(I) any portion of the 5-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer’s spouse,

law.cornell.edu/uscode/text/26/121#b_5

[Carl]

In order to qualify for the capital gains tax exclusion, you must have lived in the property for at least 720 days of the last 1826 days you owned it, counting backwards from the closing date of your sale.

If you are the sole owner and meet the above requirement, you can exclude a maximum of $250,000 of gain from taxation. If you are married, filing a joint return and both you and your spouse individually meet the requirement, then you can exclude a maximum of $500,000 of your gain from taxation.

Note I stated "maximum". Your allowed exclusion could actually be less.

When the last person to move out of the house prior to the sale is the owner of the house, you will not qualify for the full amount of the exclusion. It will be prorated based on the period of "unqualified use" prior to the time you moved in. That period of unqualified use goes back to when you purchased the property, or 1986 - Whichever is **SOONER**. In your case, the period of unqualified use would be from the date you purchased the property until the date you converted it back to personal use.

So you will only be able to exclude a percentage of your "actual" gain - not a percentage of the maximum exclusion allowed.

Also understand that depreciation recapture is not included as a part of the exclusion. You *WILL* pay taxes on 100% (one hundred percent) of the recaptured depreciation, no matter what.

All of this is covered in IRS Publication 523. But I can tell you right now, trying to read it and figure it out all in one shot *WILL* result in you being committed to a metal institution. 🙂  Best method is to read it through once to "Know it". Then the 2nd read through black out that information that does not apply to your specific situation. Then the 3rd read-through will hopefully not result in total brain failure.

[Hal_Al]

A simple (maybe an over simplification)  way to explain it is: if you rented it before you lived in it,  you will be subject to some capital gains tax.  if you rented it out  after you lived in it, it does not get taxed.

[maxwang]

So simply (if possible) speaking, as long as the rental period  ( 2 years) happened before I converted it to a primary residence, no matter how long I live in the house as primary residence (i.e. 2 years, 5 years, or 20 years), when I sell my house, I always need to prorate the gain based on the ratio ( 2 divided by total owning years)?

The part I don't understand is the Worksheet 3 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. "

[AmeliesUncle]

Yes, it will always need to be prorated.

As for that paragraph, as I said above, the IRS author misworded it.