I have owned a home for the last 5+ yrs, living in it for 3 yrs and renting it for the last 2+ yrs. We have listed it for sale, but if it doesn't sell soon, we will no longer meet the "2 of 5 yrs" rule that allows complete exception of capital gains tax.
Is the tax that we owe pro-rated if we go over the 2 of 5 rule? Or does this go from not-owing the tax to owing 100% of the tax?
I've read IRS 523, but it's super confusing. If I moved for work 2.5 yrs ago, do I qualify for a partial exception?
(This is driving me nuts because I will likely net +$160k on the sale)
The bottom line is this. To qualify for the capital gains exception, you must have lived in it for 2 of the last five years, counting backwards from the closing date on the HUD-1 statement you will receive at the closing when you sell it. What you can do is select the option for 2 of last 5. The program will ask you for days lived in, in the last 1826 days prior to the closing date. If you qualify for exceptions that allow pro-rating, the program will know "BASED ON THE DATA YOU PHYSICALY ENTER". If you don't qualify, you don't qualify.
There are exceptions for active duty military who are moved under orders. But those exceptions allow for extension of the 5 year rule, and not for a reduction of the two year rule.
You probably owe 100% of the tax.
There is a provision that if the "primary reason" for the sale was because of a job change you could qualify for a partial exclusion. However, because you HAD already met the 2 year period, the job change isn't really why you didn't meet the two year rule. The fact that your rented it for 2+ years indicates that the job change was not the "primary reason" for the sale.
This is crushing! What kind of tax rule is 100% in or out, insane! You'd think there would be a taper.
There's a change our house could sell, but with thanksgiving approaching, the time of year is bad. Any idea. Any idea what would count as "moving in" for a month or so if I need to?
It would need to be your "Principal Residence", your Main Home. So that would mean your mail is delivered there, your Driver's License is there, etc. Also, moving back in after the rental subject it to the 'prorated' exclusion. Sorry for the bad news.
Reducing the sales price could be worthwhile if it meant meeting the two year deadline.
It may take some math to see if a price reduction would be enough to matter. For example, let's I sell it at the current asking price and make a $100,000 taxable gain. If my tax bracket is 25% that means after taxes I only get to put $75,000 in my pocket if I do not sell it in time.
However, if I reduce the price to $85,000 and I "DO" sell it in time, then I get to put $80,000 in my pocket.
Were this my scenario, I'd drop the price.
Another thing you must understand too. All that depreciation you took while it was a rental is recaptured and taxed in the year you sell it, NO MATTER WHAT. What I'm saying is, you WILL pay tax on your recaptured depreciation, and there is NO WAY around that. If you did not take depreciation, then you still loose because you will pay taxes on the depreciation you *should* have taken. Just be aware of this stuff concerning your depreciation.
As a side note, if your 'regular' tax bracket is 25%, your Capital Gains tax bracket for the sale would be 15% (plus State taxes). However, the 'extra' income could affect several other things on your tax return, so it would cost much more than 15% (plus State) in taxes.
You will owe tax on the capital gains, which is not the same as the cash you get out.
Your capital gains is the difference between the adjusted cost basis and the net selling price.
The net selling price is the actual selling price minus transfer taxes, other legal fees, real estate commission, and buyer's closing costs if you pay them. (Minor pre-sale repairs and staging costs don't count, unfortunately.)
The adjusted cost basis is the price you paid, plus certain closing costs that were part of the original purchase, plus the cost of any permanent improvements you made to the property over the years, and minus any depreciation you took or could have taken when you were renting it out, and minus any casualty loss you may have claimed.
The depreciation recapture is taxed at 25% and the rest of the gain is taxed at the 15% rate for long term capital gains (for most taxpayers).
Considering the tax cost of selling after the deadline, you might want to drop your listing price to get an earlier sale, or offer to pay closing costs. Ask your real estate agent how to get a quicker sale with this in mind.
Thank you very much! How about the suspended loss carried forward during rental period (mainly from depreciation). Can it be used to offset gain from selling?
I assume if it already meets 2 out of 5 year rule then it is a moot point because given the 250k/500k exclusion, no tax due anyway.
What if it does not meet 2 out of 5 year rule? Is the sale treated the same as a sale of investment property from Day 1. In that case can suspended loss be used to offset gain?
Is it one or the other? Either benefit from 250k/500k exclusion, or offsetting suspended loss from gain?
Thank you again!
You can use both. The suspended Passive Losses will show up as an "ordinary" deduction on Schedule E. Just be sure to indicate that house was sold in the INTRODUCTORY part of the rental section, as that is what releases the Passive Loss carryover.
Thank you.
How can I report such sale in turbo tax correctly in order to reflect this was a primary converted to rental? Where can I indicate it is within 2 out of 5 years or turbo tax knows how to calculate automatically?
How can I find the exact date use to calculate the 2 out of 5 years from prior tax return or with in turbo tax?
Assuming the Fair Market Value of the home was MORE than your Basis (cost) when it was converted to a rental, just report the sale in the rental section. It will ask you if it was formerly your Principal Residence, and then just answer the followup questions.
Here's the simplified guidance again, that covers reporting the sale in the SCH E section of the program.
The "2 of last 5" look back starts from the closing date of the sale.
Reporting the Sale of Rental Property
If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.
Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in 2019". Select it. After you select the "I sold or otherwise disposed of this property in 2019" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even it it's zero. Then you MUST work through the "Sale of Assets/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).
Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets. You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset. Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1
Basically, when working through an asset you select the option for "I stopped using this asset in 2019" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.
When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.
Really appreciate it! Follow up question regarding:
"Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets...Basically, when working through an asset you select the option for "I stopped using this asset in 2019" and go from there. Note that you MUST do this for EACH AND EVERY asset listed."
In Schedule E, there are 2 condo property listed under A and B. Only B is sold. Do I have to allocate anything to A if A is not yet sold?
Thanks again.
In Schedule E,
Get off the forms mode train. In the program you work through one single property at a time. It's impossible to do otherwise. You're only working through the assets/depreciation section (which if you've done things correctly, that section is actually name "Sale of Assets/Depreciation) and reporting all listed assets as sold.
Thank you. How does calculation work actually? Say say there is a gain of $280,000. Suspended Passive Loss is $20,000. Would it take $280,000-$20,000 first, leaving $260,000 gain subject to tax. Then because there is $250,000 exclusion, $260,000-$250,000 leaves $10,000 subject to tax?
Or does it consider exclusion first? Say gain is $240,000 then since there is $250,000 exclusion it is not subject to tax. Would the same $20,000 be carried forward into future years? Or would it still consider $240,000-$20,000 which wipes out the Suspended Passive Lose, then the remaining $220,000 is excluded because it is under $250,000? But then there is no loss that can be carried forward to future years?
Thank you.
In the tax year you sell:
Take your cost basis, and from that subtract the total amount of all depreciation taken on the property. This gives you your adjusted cost basis.
Subtract your ajusted cost basis from your sales price. This gives you your gain.
From your taxable gain subtract your sales expenses. This gives your taxable gain.
Then
If you qualify for the exclusion, subtract from that gain the total of all depreciation taken on the property. This gives you the amount exempt from taxes.
The recaptured depreciation is taxed "no" "matter" "what". It is not included in the 2 of 5 exemption rule.
Now if you have losses left to carry over to ordinary income, then you didn't sell at a gain and the "2 of last 5" is a moot point.
Thank you! I was able to follow till the last few steps. Could you bear with me with hypothetical numbers to make sure I understand.
cost basis = 300,000
depreciation = 15,000
adjusted cost basis = 285,000
Scenario 1:
sale price = 575,000
gain = 290,000
sales expense = 10,000
taxable gain = 280,000
deprecation of 15,000 is taxed regardless
---If qualify for exclusion, should I take 280,000 - 15,000 = 265,000? Out of which 250,000 is exempted from taxes. There is still 15,000 left.
suspended loss carry forward = 20,000. Do I then deduct 15,000 of it to wipe out the gain and there is still 5,000 suspended loss to carry forward for future years? In this case, I benefit from both 2 of 5 exclusion and release of suspended loss?
---If not qualify for exclusion, should I still take 280,000 - 15,000 = 265,000? out of which 0 is exempted.
suspended loss carry forward = 20,000. Can I then deduct all of it and the remaining 265,000 - 20,000 = 245,000 is subject to capital gain tax?
Scenario 2:
sale price = 535,000
gain = 250,000
sales expense = 10,000
taxable gain = 240,000
deprecation of 15,000 is taxed regardless
---If qualify for exclusion, should I take 240,000 - 15,000 = 225,000? All of it is exempted from taxes
suspended loss carry forward = 20,000. It is not used, do I carry it forward for future years?
---If not qualify for exclusion, should I still take 240,000 - 15,000 = 225,000? out of which 0 is exempted.
suspended loss carry forward = 20,000. Can I then deduct all of it and the remaining 245,000 - 20,000 = 225,000 is subject to capital gain tax?
Not sure if I'm making sense.
Thank you.
The suspended loss is fully released when you sell the property in a fully taxable transaction. So you get that $20,000 deduction no matter what. It has no effect on the gain/loss calculation; it is a separate deduction and shows up on Schedule E.
Not sure if the guidance has changed but doesn't the IRS presume you sold by reason of home move
If a safe harbor described in this section applies, a sale or exchange is deemed
There is a bulletin from 2004 that gives further commentary that says whatever the rational for the sale, if the homeowner meets these safe harbor qualifiers they won't be challenged. I think the original poster would qualify. There are no automatic dis-qualifiers such as renting the home that I can find.
nternal Revenue Bulletin: 2004-39 | Internal Revenue Service (irs.gov)
One commentator asserted that the factors are beyond Congressional intent, unnecessary, and overbroad. The final regulations retain the list of factors because it is helpful in determining the taxpayer’s primary reason for the sale or exchange.
For each of the three grounds for claiming a reduced maximum exclusion, the temporary regulations provide a general definition and one or more safe harbors. Under the temporary regulations, if a safe harbor applies, the taxpayer’s “primary reason” for the sale or exchange is deemed to be change in place of employment, health, or unforeseen circumstances.
Yes, if the original poster was living in the home when he had the job change, he would qualify for the Reduced Maximum Exclusion (assuming the job change met the distance requirements).
But if the original poster had already moved out of the home when they had the job change, they would not qualify.