Selling of two homes in same year

[sk4000sk2]

Hi..I purchased a property "A" in 2007 and I lived in it until Dec 2016. Thereafter, I rented the property and purchased a new property "B", which became my primary residence. The renter left in Oct 2019. I renovated the property "A" and put it up for sale. I was not able to sell the property "A" until Feb 2021. Also, in Feb 2021, I decided to purchase a new property "C", which would become my primary residence. I have put the property "B" for sale as well and hope to sell by March / April 2021. Will I have to pay capital gains tax on either property "A" or "B" OR or both properties "A" + "B", even if the gain on both properties combined is less than 500K? I am married and have been filing joint tax returns.

[DavidD66]

You will have to pay capital gains tax on property A, as it does not qualify as your primary residence.  And since it was a rental property, you will have to pay depreciation recapture (to the extent you have a gain) on the amount of depreciation you were entitled to take while it was a rental.  For property B, as long as  you lived in it as your primary residence for 24 of the 60 months immediately preceding the sale of the property, you can exclude $250,000 ($500,000 if Married Filing Joint) of gain on the sale of the property.

[sk4000sk2]

Buying a new property after selling a secondary property "A" will not consider an even exchange.

[Opus 17]

The idea that you can postpone the gain on selling your home by buying another home within a certain timeframe was written out of the tax law more than 15 years ago.  

The current rules are relatively straightforward. You can exclude the gain on your main home if you have owned it at least two years and if you lived in it as your main home for at least two years of the five years before selling. In other words, because you rented home A for more than three years after you moved out, you do not qualify to take the exclusion on home A. 

You appear to qualify to exclude the gain on home B.

Even if you had qualified to exclude the gain on both homes, you can only use the exclusion once every two years.  And even if you did qualify to exclude the gain on home A, you must still deal with the depreciation and pay depreciation recapture.

A “like kind exchange“ allows you to postpone the gain on business property if, when you sell it, you acquire a similar piece of business property at about the same time.  That might have allowed you to defer the gain on home A, but only if you had purchased a new home D to use as a rental property at about the same time that you sold home A.   If you want to defer the gain on home A to buy a new rental home D, it may already be too late, and if not, you need to get on the stick and find a property and get an accountant to make sure you qualify.

[sk4000sk2]

Many thanks again. Just want to clarify - Home A was only rented from Dec 16 to Oct 19 so it is rented less than 3 years. Since Oct 19 it is not used by anyone other than me and my family. I even paid all utilities on the home.

Secondly, you mentioned, quote "Even if you had qualified to exclude the gain on both homes, you can only use the exclusion once every two years. And even if you did qualify to exclude the gain on home A, you must still deal with the depreciation and pay depreciation recapture." I have never used this exclusion on taxes so how do I use it?  I do not mind paying taxes only on depreciation recapture.

[Opus 17]

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@sk4000sk2 wrote:

Many thanks again. Just want to clarify - Home A was only rented from Dec 16 to Oct 19 so it is rented less than 3 years. Since Oct 19 it is not used by anyone other than me and my family. I even paid all utilities on the home.

Secondly, you mentioned, quote "Even if you had qualified to exclude the gain on both homes, you can only use the exclusion once every two years. And even if you did qualify to exclude the gain on home A, you must still deal with the depreciation and pay depreciation recapture." I have never used this exclusion on taxes so how do I use it?  I do not mind paying taxes only on depreciation recapture.

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To use the exclusion, you must have lived in the home at least 2 years of the past 5 years, it doesn't matter if it was rented or vacant or under renovation.  I may not have been precise enough in my wording.  Since home A was sold in Feb 2021, you would have to have lived in it as your main home for at least 731 days since Feb 2016.  The days do not have to be consecutive, but it must have been your main home.

Since you only qualify to use the exclusion on home B, this is what will happen on your 2021 tax return:

If you don't get a 1099-S at the closing, and your gain is less than $500,000, then you don't even have to report it on your tax return.  If you do get a 1099-S at the closing, you must report it.  Use the section for "sale of my main home" in the Income area for sales of assets and other property.  Turbotax will ask some questions about the purchase price, improvements, selling price and your qualifications for the exclusion, and as long as the gain is less than $500,000, you won't pay tax even though the sale will be reported.

For home A, you will list that as the sale of a rental home.  You will need to provide information about the purchase price, cost of improvements (not repairs), and depreciation you claimed or could have claimed.  You will pay recapture tax on the part of the gain due to depreciation (regular tax rates up to a maximum of 25%) and you will pay long term capital gains tax (usually 15%) on any additional gain. 

If you did actually live in home A for 731 days since Feb 2016, and you also lived in home B as your main home for 731 days since you bought it in December 2016, then you could qualify to use the exclusion on either home, but you can only use the exclusion once every 2 years, so you would exclude the gain on one home and pay the capital gains tax on the other. 

[sk4000sk2]

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.

[Opus 17]

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@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.

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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.

[marcrecht]

Randomly came across this in searching for some info -- I'm wondering if in this example the capital gains from the primary home affect the tax rate for capital gains in the rental property. In short, if i sell two home in one year will my capital gains tax for the rental property be adversely impacted by the additional gain in my primary home sale? Or does the 500k exemption (married filing jointly) mean it is completely spared from any calculation.

Thanks to anybody who has an answer!

[Opus 17]

@marcrecht 

if the sale of the primary home qualifies for the exclusion, the gain is excluded from taxable income.  In other words, it doesn’t add to any income figure that would be used to calculate AGI or MAGI and would not count as income for purposes of determining whether a separate gain should be taxed at the 15% or 20% rate.

[marcrecht]

Ok that's what i thought but kind of wanted to be sure before receiving an ugly surprise.

Thanks so much for your reply and happy holidays!