Primary residence 2 out of 5 rule

[marcrecht]

Hello all,

We purchased a new home, a primary residence, and lived there for one year. At the end of that year we purchased another home, moved in, and rented the primary residence for almost 2 years. During this time we occasionally lived in the new home and about half or more of the time we had both homes rented and were traveling or working in other cities.

We then came back to the primary residence and will have 2 out of 5 years but I am seeing mixed things about whether some of these rented days will turn this into a prorated exclusion of our 500k (married filed jointly) exemption.  Even the IRS Publication 523 makes zero mention of this kind of example or situation, and it seems to possibly only apply if you buy a property as an investment and then later try to convert it to a primary. Is this a cut and dry situation?

Follow up, is there any way to fix it if i did create a problem? Seems like worst case I'm prorating rented vs. used days vs. the 500k exception, but I feel like the IRS is telling me I'm good for the whole thing. Thanks in advance!

[DavidD66]

it is, as you say - pretty cut and dry.  If you lived in the house and it was your primary residence for any 24 of the 60 months leading up to the time you sold it, you qualify for the $500,000 tax exemption on the sale of the house.  Having rented the house part of the time you weren't living there has no effect on the exemption amount.  However, because it was a rental, to the extent you have a gain you will be subject to depreciation recapture tax on the amount of depreciation you took, or were eligible to take while it was a rental.   For example, if you sold your house for a $500,000 gain, and during the time the house was rented you took (or were eligible to take) $25,000 in depreciation expense), you will owe depreciation recapture tax on that $25,000.  The remainder of your gain will be tax exempt.  

[marcrecht]

Great -- thanks so much for this. I didn't mention the depreciation but we are aware we will need to pay that.

Cheers