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?

[rorsa1]

I bought a condominium a little over 4 years ago and now wish to sell.  I lived in the property for 1 year 9 months, then moved out so that I could live in a shared apartment with my fiancee.  I then rented the condo out for the next 2 years and 6 months.  I now realize I need to have lived in it for 3 more months to qualify for the primary residence tax exemption, which exempts you from 250,000 in gains if you live in the property for 2 of the last 5 years.  If I move in for 3 months prior to selling, will I be qualified for the $250,000 exemption?

[Opus 17]

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.

[rorsa1]

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?

[Opus 17]

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-publicati...>

[taxman6236]

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"

[TaxGuyBill]

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

[taxman6236]

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.

[taxman6236]

@TaxGuyBill  Am I wrong?

[TaxGuyBill]

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.

[Opus 17]

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.

[TaxGuyBill]

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

[taxman6236]

@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.

[Opus 17]

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

[taxman6236]

So we need to pull the statute?

[taxman6236]

"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."