Capital Gains exclusion on sale of home

[angeliagblin]

My husband and and I bought our home 24 years ago and lived in it for the first 18 and we have rented it out since 2016. We have chosen to live abroad for the last 6 years as my mother-in-law was unwell and died in 2018.

Do we meet the exception to the 2 out of 5 years residence eligibility rule for properties rented out after 2008? Do we qualify for the 500k capital gains exclusion if we sold our home now? 

[NCperson]

to be eligible for the exclusion you must have lived in your home for 2 of the past 5 years.  from what you wrote, you did not, so you are not eligible for the exclusion.

<<2 out of 5 years residence eligibility rule for properties rented out after 2008>>

I am not aware of this rule - where did you get this idea from? are you confusing it with something else? 

[Mike9241]

@NCperson see IRC sec 121(b)(5)(C)(i) but they are misinterpreting this rule because of 121(b)(5)(C)(ii)

[angeliagblin]

From pub 523 (2021) page 4

Eligibility Step 5—Exceptions to the Eligibility Test...

•You used the entire property as a vacation home or rental after 2008 or you used a portion of the home, separate from the living area, for business or rental purposes.

Do we qualify for the exclusion?

[angeliagblin]

cannot find 121(b)(5)(i) or (ii) in irs.gov

[NCperson]

https://www.law.cornell.edu/uscode/text/26/121

[Opus 17]

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@angeliagblin wrote:

From pub 523 (2021) page 4

Eligibility Step 5—Exceptions to the Eligibility Test...

•You used the entire property as a vacation home or rental after 2008 or you used a portion of the home, separate from the living area, for business or rental purposes.

Do we qualify for the exclusion?

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No, you do not.

The exception referred to results in some people owing more tax, not less.  Suppose you moved out in 2016, used the property as a rental for 4 years, and then moved back in 2020 and sold in 2022.  You would qualify for the exclusion because you lived in the home at least 2 of the 5 prior years, but you still have to pay capital gains tax for the portion of the gain that occurred during the 4 year rental period.  The exclusion does not cover certain rental periods after 2008 even if you move back into the home for 2 years before selling.  

That rule also means that even if you moved back into the home now and waited 2 more years to sell, you can only apply the exclusion to 20/26ths of your gain.  (You owned for 26 years but only lived in the home as your main home for 20 of those years.  The 6 year rental period from 2016-2022 is not qualified for the exclusion.)

As it stands now, you simply don't qualify at all. 

[angeliagblin]

Can Turbo tax handle these calculations of apportioning the gains?

Are there any tax payers who have gone through filing under these circumstances?

[Opus 17]

@angeliagblin 

yes, TurboTax includes the calculations for non-qualified periods of ownership.  The calculation is also contained in the worksheets in publication 523. The difficulty is the last time publication 523 actually tried to explain the calculation was about 2013. Since then the worksheets include the calculation, but the publication doesn’t try to do a good job to explain the issue.

basically, if you move out, and sell within three years so that you meet the two out of five rule, the period of time when you did not live in the home before selling is still considered qualified. But if you move back into the home before selling, then the period of time when you were not living in the home is not qualified. The exclusion is meant to protect homeowners, not give a tax break to landlords by allowing them to move back into their home for two years and then being able to exclude all of the gain from when they were a landlord/investor. 

[Edited to add: As @Anonymous_  says, you are not eligible for any exclusion as things stand.  If you moved back into the home and used it as your main residence for 2 years before selling, you can use a partial exclusion and TurboTax will perform that calculation.]

[Anonymous_]

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@angeliagblin wrote:

Can Turbo tax handle these calculations of apportioning the gains?

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You would not qualify for any "apportionment" of the gains" (i.e., applying the exclusion to part of your gain) if you did not (or do not) move back into the property during the past five years prior to the property being sold (the last use of your property was rental use).

In fact, you should have been taking depreciation deductions on the property during the rental period along with reporting the income and expenses from the rental. If you have not, that is another problem which will require the intervention of a tax professional.

[angeliagblin]

Understand. Thanks for your explanation.