IRS 121 EXCLUSION primary to rental to primary

[GDL3]

Hello! Can someone tell me if a rental period of my main residence is qualified or nonqualified for the 121 exclusion?

For context, I bought a home in Las Vegas, NV in August 2009 as my primary residence and I lived there for almost 3 years (33 months technically) and then I moved out and rented it out for 7 years. Then I moved back in and used it as my primary residence again for the last 5 years. I applied for a 121 exclusion for the first and only time in 2006 and I have heard references that the rental period is nonqualified but also, that there's an exclusion to the nonqualified use but no one locally can fully explain them to me. The capital gain that I would have if I sell would be around 200K. Can somebody tell me what's right?

Thank you so much!!

[M-MTax]

Gain from the sale or exchange of your main home isn’t excludable from income if it is allocable to periods of nonqualified use. Nonqualified use means any period after 2008 where neither you nor your spouse (or your former spouse) used the property as your main home, with certain exceptions.

[M-MTax]

Read through Pub 523 especially the worksheet.

[Mike9241 · Accepted solution]

first depreciation allowed or allowable during the rental period must be recaptured as section 1250 gain

of the remaining gain, the amount that does not qualify for 121 treatment (ie exclusion) is period of rental (nonqualified use) divided by period of ownership times $250,000 (assuming you're not married)

period of nonqualified use is any time after 2008 when it was not used as your personal residence.

using your net gain of $200K say $15K was depreciation allowed or allowable. that gets taxed as section 1250 gain, that leaves $185 of gain 

say you sell it 10/1/2024. (your months don't quite add up so)

period of ownership:  say 8/1/2009 to 9/30//2024 = 182 months

period of nonqualified use 7 years (the months rented) = 84 months

nonexcludable gain 84/182 times $250K (assuming you are not married) or about $115K that will be taxed as long-term capital gain. the remaining gain of $70K is excludable. 

[Opus 17]

The 7 years is non-qualified.  If you sell in 2024 (owned for 15 years, 7 years non-qualified) that means that 7/15th of the gain is taxable.  If your gain is $200K, then $93,000 is taxable, and the remaining $107K can be applied to your 250K personal exclusion.  You will also have to pay depreciation recapture on the depreciation you claimed or could have claimed while the home was a rental.

The worksheets in publication 523 will walk you through the calculation, but they don't do a good job of explaining why the worksheets calculations work the way they do.  You have to go back to about 2013 to find a version of pub 523 that tries to explain non-qualified use. (The term isn't even used in the current version.)

I will try to explain briefly.

Congress does not want landlords to get a full exclusion just by moving back into their home at the last minute.  If you move out of your personal residence, rent briefly (up to 3 years), and then sell, the rental period is qualified.  But if you move back in as your personal residence again the rental period becomes non-qualified.  Here's an example of how the math would work in your case.

• Purchased for 200K
• Rented for 7 years, so you took or should have taken deprecation of about $45K.  Your adjusted cost basis is reduced to $155K.
• Currently have lived there at least 2 years so qualify for the exclusion.
• You have made $20K of improvements which increase your cost basis to $175K.
• Sell for $400K.
• 7/15th of the gain is non-qualified and 8/15th is qualified.
• Your capital gain is $225K, because it is calculated from the adjusted cost basis after depreciation and improvements.  
• First, you pay depreciation recapture on the 45K of depreciation.  Depreciation recapture is taxed as ordinary income (your normal tax bracket) with a cap of 25%.  
• The remaining long-term capital gain is $180K.  Because 7/15th is not qualified, it is subject to long term capital gains tax ($84K).  The 8/15th that is qualified ($96K) is eligible for the personal exclusion.  Since the gain is less than the exclusion limit, that portion of the gain is excluded.  You end up paying recapture tax on the depreciation and long term capital gains tax on 7/15th of the other gain. 
•  

[GDL3]

Thank you for the answer and for your time. I really appreciate it.

[GDL3]

Thank you so much for answering and for your time. Do you think it would be a good idea to go to my local IRS office to ask about this?

[M-MTax]

Do you think it would be a good idea to go to my local IRS office to ask about this?

You could always try but they're not there to give you tax advice or help you prepare your return. They'll suggest that you see a tax pro.