I bought a property and lived in it for 1.75 years, then rented it out for 2.5 years. If I move back in for 0.25 years will I qualify for the $250,000 primary exemption?

Yes and no.  That situation (move back in) is complicated and not well documented in the IRS instructions, although Turbotax will calculate it.

The "move back in" situation is an exception to the general exclusion rule because Congress didn't want landlords turning taxable rental property into tax-free personal property.  When you live in the home you own, move out, and sell within 3 years (to meet the 5 year rule) there is no problem.  But when you move out and move back in, things get messy.

You have to deal with periods of "non-qualified use".  The gain due to non-qualified use is not covered by the exclusion.  In your case, if you move back for 3 months and sell, you will have lived in the property for 24 months during the last 5 years, and owned it for a total of 54 months.  But 30 months is non-qualified use.  So you will owe capital gains tax on 30/54ths of your gain.  The 24/54ths of gain that is from qualified use is subject to the exclusion.

So, supposing your gain is $100,000; then $44,000 is qualified and subject to the exclusion, and $56,000 is non-qualified gain and subject to capital gains tax.

In addition, the depreciation you took or could have taken while you were renting the property will be subject to 25% recapture tax in any scenario.

Note that the longer you live there, the higher your percentage of qualified gain.  For example, if you lived there 3 more years, you would have 57/87ths of qualified use, meaning you could exclude 65% of your gain up to $250,000.

You would certainly save something if you moved back, its up to you if its worth it.

Thanks for the response, that's very helpful.  As a followup question, if I don't 'move back in' for 3 months will I be able to prorate the exemption for the 1.75 years I lived there by taking 1.75/2.0 multiplied by $250,000 without being penalized for changing it back to a primary?

Probably not.  The requirement that you live there for two years of the previous five years  (24 months of the previous 60 months)  is pretty much a minimum basic starting requirement for any conversation about exclusion.  

There is a "hardship" provision that allows you to prorate the exclusion, but it only applies if the reason you move out is due to an involuntary and unforeseen event.   Examples include military deployment, a change in health status that makes living in the existing home impossible, or a change of job that requires you to move.  Even when using the hardship  provision to get a partial exclusion, you have to sell within a reasonable period of time of moving out. Converting it to a rental would not generally be allowed unless you can show that market conditions made it impossible for you to sell at that time. The goal of Congress when they created these provisions was to assist residential homeowners, not landlords.

 You can read the partial exclusion rules in IRS publication 523. If you decide you qualify for a partial exclusion, you don't send proof with your tax return, but you must keep the proof available for at least six years in case of an audit. <a rel="nofollow" target="_blank" href="https://www.irs.gov/forms-pubs/about-publication-523">https://www.irs.gov/forms-pubs/about-publication-523</a>

Are these answers even vetted?

"If you owned the home and used it as your residence for at least 24 months of the previous 5 years, you
meet the residence requirement. The 24 months of residence can fall anywhere within the 5-year period, and it doesn't have to be a single block of time"

@taxman6236   Yes, that meets the residence requirement.  That does NOT mean they qualify to exclude ALL of the gain.  The original answer is correct.

They lived in the property first, then rented. Non-qualified use only applies when you rent first then live in the property.

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 that the property as a main home.

@TaxGuyBill  Am I wrong?

You are correct about that

The original question asked if they can move back in AFTER it was rented in order to meet the two year requirement.  So that would have triggered the rental period to be Nonqualified Use.  As I said before, the original answer is correct.

In the original question, the period of non-use occurred both AFTER they used it as their main home, but also BEFORE they used it as their main home (because they moved back).

Timeline
Main home ---->rental---->sale   does not trigger the non-use rule.

Main home --->rental--->main home--->sale  does trigger the non-use rule.

You have to go back to around 2010 to find a version of IRS pub 523 that does a good job explaining this.  Most recent versions omit the details and refer the taxpayer to a tax preparer for extra help.

Publication 523 was good in 2013, but the IRS completely screwed it up in 2014 and new versions.

@TaxGuyBill @Opus 17  Now the conversation is diverging into which year's guidance is more applicable. We have the version available now and as I read the guidance provided above
Main home ---> rental ---> main home --> sale provides exclusion from Capital Gains, given the eligibility test is met.

"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 that the property as a main home."

The sentences are connected with AND requiring both qualifications before applying.

The tax code hasn’t changed, just the quality of the IRS publications that attempt to explain the code to the average taxpayer.  

So we need to pull the statute?

"The  24  months  of  residence  can  fall  anywhere  within  the  5-year  period,  and  it doesn'tt  have  to  be  a  single  block  of  time.  All  that  is  required  is  a  total  of  24  months  (730  days)  of  residence  during  the  5-year  period."  

Yes, read the Code.  The Code had not changed, nor anything else official.  Only the poor revision of Publication 523 has changed.


(C) Period of nonqualified useFor purposes of this paragraph—
(i) In general

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.
(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,
(II) any period (not to exceed an aggregate period of 10 years) during which the taxpayer or the taxpayer’s spouse is serving on qualified official extended duty (as defined in subsection (d)(9)(C)) described in clause (i), (ii), or (iii) of subsection (d)(9)(A), and
(III) any other period of temporary absence (not to exceed an aggregate period of 2 years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the Secretary.

<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/uscode/text/26/121#b_5">https://www.law.cornell.edu/uscode/text/26/121#b_5</a>

<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/uscode/text/26/121">https://www.law.cornell.edu/uscode/text/26/121</a>

(C) Period of nonqualified useFor purposes of this paragraph—
  (i) In general
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.
  (ii) Exceptions The 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,
     (II) any period (not to exceed an aggregate period of 10 years) during which the taxpayer or the taxpayer’s spouse is serving on qualified official extended duty (as defined in subsection (d)(9)(C)) described in clause (i), (ii), or (iii) of subsection (d)(9)(A), and
     (III) any other period of temporary absence (not to exceed an aggregate period of 2 years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the Secretary.



Let me call out section (C)(ii)(I)
"The term “period of nonqualified use” does not include...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,"

So ANY period of non-use is non-use, EXCEPT for periods that occur AFTER THE LAST DATE the property is used.

So let's consider.

Bought on 1/1/14
Rented on 1/1/16  (2 years of qualified use)
Sell on 1/1/18 (these 2 years fall under the exception in (C)(ii)(I) , so it is considered qualified use and all gain is excludable)

Bought on 1/1/14
Rented on 1/1/15
Convert back to residence on 1/1/16
Sell on 1/1/17
The homeowner has 2 total years of qualified use, which, although not in a single block, still satisfies section (a).   But the period of time from 1/1/15 to 1/1/16 when it was rented is non-qualified use.  It does NOT fall under the exception granted in (C)(ii)(I), because it is not AFTER THE LAST DATE the property was used as a principle residence.


The section you selected describes that the 2 year rule can be satisfied in aggregate rather than a single block of time.  That is IRC 121(a).  But you are ignoring that the limitations in IRC 121(b) have an entirely separate set of rules, of which 121(b)(5)(C)(ii)(I) is but one.

Bought 2009 (used as primary residence)

Rented 7/15/2016 (purchased another home this year to use as primary residence)

Sold 11/8/2019

Status:  Married, filing jointly

Question:  I am trying to determine if we qualify for home sale exclusion, partial exclusion, or none at all.   We lived in the home as our primary residence for almost 7 years.   ***Note - I am trying to determine if the exception to "period of nonqualified use" grants us the opportunity to qualify for tax exclusion as it seems we missed the mark by about 4 months).   Can we claim a partial exclusion for the 20 months we lived in it of the 5 years prior to sale?  Your help is greatly appreciated.  

From what I see it doesn't appear a partial exclusion applies.  However here is the Publication that discusses the potential qualifications for the partial exclusion.  Basically, the sale has to be work-related, health-related, due to unforseen events, or due to other uncontrollable facts and circumstances.  You may find something in those latter paragraphs that has not been shared here.  

This is a good discussion! I have similar question, but different than the situation in the example. What if I bought the house, rented it for 2 years, and live there for 5 years, sold it. Is the capital gain (assume 140K) exemption calculated proportionally, only 5/7 * 140 = 100K exempted? Reading the section B, the non-qualified use did not happen in the past 5 years before sell, should the whole 140K get exempted? 

@yangyingtina - Only 5/7 of the gain is excludable.

2/7 + depreciation recapture is taxable. 

I also have this question along the same lines.  We are about to sell condo, closing with luck on May 1, 2020.  Trying to figure exclusion.  We do meet eligibility for full $500,000 exclusion, but I cannot figure out the non-use area.  I keep re-reading, think I understand, only to read again and get more confused.  For example, do we count ANY of the period prior to the 5 years before sale?  If so, that would mean 1/1/2009 - 11/24/2014 would be considered in the calculations for non-use.  ANY help would be immensely appreciated --

Owned since 10/30/87

Period from 1/1/2009 - 11/24/2014 - Rented most of that time 

Moved back in - 11/25/2014 - 12/31/2017

Bought house out of state as of 1/1/2018

Condo empty, not rented, to date of sale which will be 5/1/2020.

So out of the 5 years before the upcoming date of sale, we lived in it for a full 3 years (at beginning of 5 year period).  It has been empty the last two years.

This is strictly determined during the 5-year period ending on the date of the sale, please read this IRS link for more details.

I've read many of the publications, the 2013 and 2019 Publication 523s most helpful and clear with examples.  However, are you saying I don't even have to consider the period 1/1/2009 - 11/24/2014?  I ONLY have to deal with the 5 year period preceding the sale?  Which would be from 5/1/2015 to 5/1/2020.  That would be great because here I was counting all the days from 1/1/2009 that we were not living in the property. 

@GSL2457 I assume it was  also your home from 10/30/87 to 1/1/09.

The period from 1/1/09 to 11/24/14 was non qualified use.

You meet the 2 out of 5 year requirement, if sold before 12/31/20.

You lived in the home 292* months and had 71 months of non qualified use.  ~80% (292 / (292+71) of your gain is excludable, up to $500,000.  ~20% and depreciation recapture is taxable.

TurboTax handles this very smoothly.  Enter at Home sale, under Less Common Income.

*I'm not sure, but the vacant time prior to sale may also count as qualified use for purposes of the tax calculation (but not for the 2/5 rule)