“Qualified Use” of Our Residence While Working as Foreign Service Officer (FSO) Overseas

[FSORetiree]

My wife and I sold our house in Virginia in April 2020, shortly after I retired in September 2019 from a long career working mostly overseas on official extended duty as a U.S. Foreign Service Officer (FSO). I want to know if I correctly understand 26 U.S.C., Section 121 laws that apply to our eligibility to exclude gain from the sale of a principal residence. Specifically, I want to confirm that the time our house was rented out while I was on official extended duty overseas can be considered as “qualified use” of our residence. This will allow us to consider most of our home ownership from 1997-2020 as “qualified use” so that we can make use of the majority of the $500,00 capital gains exclusion (for married couples filing jointly) on the sale of our principal residence.

We purchased our Virginia home in 1997 and used it as our principal residence for two years before renting it out in 1999. From 1999-2014, we mostly rented out the house during several overseas assignments, although we moved back into the house once from 7/4/2010-6/30/2011. I know from 26 U.S.C., Section 121 (b)(5)(C)(i) that the entire period prior to January 1, 2009 can be considered as “qualified use.”

From 1/1/2009-7/4/2010, I was assigned overseas on official extended duty, accompanied by my family. During this time, we rented out our Virginia house. From 7/4/2010-6/30/2011, we moved back into our Virginia house and used it as our principal residence. From 7/1/2011 to 7/3/2014, I was again on official extended duty overseas with my family, and we rented out our house. On 7/3/2014, we moved back into our house, using it again as our principal residence until selling it on 4/29/2020, shortly after I retired in September 2019.

I’m certain that we qualify to take the Section 121 exclusion of up to $500,000 of capital gains for married couples filing jointly, but I need to know:

(1) Whether the time we rented out our house from 1/1/2009-7/4/2010 and 7/1/2011-7/3/2014 can be considered as “qualified use” of our house. This would be my interpretation of 26 U.S.C., Section 121 (b)(5)(C)(ii)(II). By reducing the total time of “non-qualified use” of our house over the time we owned it from 1997-2020, we can benefit from the majority of the $500,000 exclusion.

(2) Or, does this rule only apply to one continuous stretch of time that can’t be interrupted by a time when the taxpayer is using the house as his principal residence, as we did from 7/4/2010-6/30/2011? In that case, would this mean only 7/1/2011-7/3/2014 would be “qualified use?”

For the applicable regulations, see, for example, https://www.law.cornell.edu/uscode/text/26/121. I know that regardless of the response to these questions, we’ll still need to pay tax on recaptured depreciation. Thanks for any advice anyone can provide.

[pk]

@FSORetiree , what I get from your post is that 

(a) you bought a property in 1997 and used it as your main home  for the period 1997 thru 1999 as your main home

(b) you had various periods of using the property as  income property

(c) from 7/3/2014 through 4/29/2020 the property was your main residence 

(d) you sold the property on 4/29/2020

Now the question is can you exclude the  gain on the property  since  it was your main home.

To avail of the this special  exclusion of gain from the main residence  :

1. with a look back period of  five years  from the sale date  i.e.   from 4/29/2020 till 4/29 2015

 --- (a) at least one spouse  has owned the  property for two years

---(b) both spouses have used this property as main residence for a total of  730 days 

2. in your particular case  you meet both the requirements  because you have owned the  property since 1997 and because you have both used the property  as main home  since  7/3/2014 through 4/29/2020.

The gain  is determined  ( and TurboTax will do all the work for you on this ) as  Sales Proceeds  ( which is Sales Price LESS sales expenses such as  realestate commission, transfer taxes, title  insurance etc. etc.) LESS adjusted Basis ( which is  acquisition cost plus cost any improvements etc. LESS accumulated  allowable depreciation ).  This  gain is now broken into two parts --- (a) the accumulated depreciation  that is treated as "recapture amount"  and taxed as ordinary income,  and (b) Capital gain that is eligible for exclusion  up to $500,000 for a couple. Any gain that is not  excluded  or given ordinary treatment is  now taxed at Capital gain rates .

Since you already meet the   " usage  requirements"  by having used the property as your main residence during 7/3/2014 through disposition date, the need for applying "qualified usage rules" do not arise.

Does this answer your query?

3. 

[FSORetiree]

PK:

Thanks for taking the time to post an answer to my question, but I already knew that my wife and I meet all the eligibility tests to qualify for an exclusion of up to $500,000 of our capital gain from selling the house.  

The question I have relates to how much of the $500,000 exclusion we can use, which requires calculating the “nonqualified use” gain, which I understand is computed by dividing the total number of “nonqualified use” days over the total number of days we owned the home.   I need to know whether or not I am correct in my interpretation of certain 26 U.S.C., Section 121 laws that apply to our eligibility to exclude gain from the sale of our principal residence.

Specifically, I want to confirm that the time our house was rented out while I was on official extended duty overseas on our last two assignments prior to 7/3/2014 can be considered as “qualified use” of our residence, even though we rented out our house while we were overseas. This would allow us to consider all of our home ownership from 1997-2020 as “qualified use” such that we would be able to benefit from the entire $500,000 capital gains exclusion (for married couples filing jointly).

Timeline
7/31/1997 Purchased our home, used it as our principal residence for the first two years.

9/27/1999 Rented out our home for the first time while overseas on official duty.

9/27/1999-12/31/2008 Tax laws stipulate all use can be considered as “qualified,” so I’m not providing details on this period. See 26 U.S.C., Section 121 (b)(5)(C)(i).

1/1/2009- New tax laws stipulated use can be considered as either qualified or nonqualified.

1/1/2009-6/30/2010 Rented out home while overseas on official duty.

7/4/2010-6/30/2011 Moved back into residence for one year.

7/1/2011-6/30/2014 Rented out home while overseas on official duty.

7/3/2014 to 4/29/2020 Moved back into residence and lived in it for 5+ years before selling it.

Thanks for any advice you can offer.