House Sale: What Happens If I Don't Meet 2 of 5 yr Residency

[cc11jimmy]

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.

@AmeliesUncle 

[Carl]

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.

[cc11jimmy]

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.

[AmeliesUncle]

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.

[Chris981]

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 to be by reason of a change in place of employment, health, or unforeseen circumstances.

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. 

[AmeliesUncle]

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.