Capital Tax Gain Exemption for this case

[gouriyashodhan]

Hi, 

We purchased a condo few years back and we lived in that condo for 1 year. When we purchased I was jobless and was looking for a job and found a job after we moved. My new job was 22 miles away from our condo location. Although the job location was just at a 45 mins driving distance away from the condo, it took up to 1.5 hrs to commute one-way because of the peak hours.  I was commuting everyday to my work location and during this time I was expecting a baby.  So the entire pregnancy I commuted but thought I won't be able to leave the baby at daycare or nanny at/near my home and go to work which will take up to 1.5 hrs to come home in case there is any emergency. 

So we decided to rent the condo and move out. We rented an apartment near my job location.  After more than a year, we decided to buy a house and sell the condo. So we first bought a house and then sold the condo. 

My question is - do we qualify for capital tax gains exemption? 

[Opus 17]

You need to review publication 523, especially starting on page 6.

https://www.irs.gov/forms-pubs/about-publication-523

You don't provide enough details.

Firstly, you don't qualify for the safe harbor, since your commute is less than 50 miles.  The safe harbor is a set of situations that, if you fit them, the IRS won't question the exclusion.  There is also a "facts and circumstances" rule that does not require you to fit any particular set of conditions.  You just have to show by facts and circumstances that your changed situation was unforeseeable when you bought the home, and created a burden in keeping the home.  You don't send proof when you file, but keep the proof of your circumstances for at least 3 years in case of audit.

But more importantly, there are some rules you can get around that way but some rules you can't.  What we need to know is when did you buy the home, when did you stop using it as your main home and when did you sell it.

The general rule is that you must own the home at least 2 years and live in the home as your main home for at least 2 of the past 5 years before the sale.  In other words, you must sell the home within 3 years of moving out. The hardship rule can help you if you stop using the home as your main home in less than 2 years, but it doesn't help you if you wait more than 3 years to sell after moving out.  

For example, suppose you bought the home June 1, 2019.  You moved out June 1, 2020 and rented it, and you sold it August 30, 2022.  You could claim a partial exclusion since you moved out for a hardship and sold the condo less than 3 years after moving out.   But if you bought June 1, 2017, moved out June 1, 2018, and sold in August 2022, then you waited too long after moving out to use the partial exclusion, even if you moved out due to a hardship.

The exclusion for hardship is partial.  The normal exclusion is $500,000 for spouses who file jointly.  If you lived in the home as your main home for 10 months, the partial exclusion would be 10/24=41.7% x $500,000 = $208,333.  Any gain over that is taxable.

And remember also, you must deal with the rental situation, and that includes paying depreciation recapture on any part of the gain that comes from depreciation you claimed or could have claimed while the condo was a rental.  That part of the gain is not subject to any exclusions. 

[gouriyashodhan]

Aug 2017 - we bought condo
July 2018 - we moved out of the condo and rented the condo + same month we had a baby
July 2020 - we bought our house
Oct 2021 - we sold our condo

Also another reason to buy a house and then sell the condo was - since we had a second child, the small 3 bedroom condo with a home office was not sufficient for us. So that also convinced us to sell the condo and buy a single family house. 

Please let me know if still qualify for partial of full capital gains exclusion. 

Since we are filing the tax returns for 2021 and we are already late, can we for now just file returns and later file an amendment asking for exemption with this whole capital gains thing (if we qualify)?  

[Mike9241]

your situation should be reviewed by a tax pro, the fact that you waited more than 3 years after moving out may be an issue

here's from IRS reg 1.121-3 reduced exclusion

Factors that may be relevant in determining the taxpayer's primary reason for the sale or exchange include (but are not limited to) the extent to which -

(1) The sale or exchange and the circumstances giving rise to the sale or exchange are proximate in time;

(2) The suitability of the property as the taxpayer's principal residence materially changes;

(3) The taxpayer's financial ability to maintain the property is materially impaired;

(4) The taxpayer uses the property as the taxpayer's residence during the period of the taxpayer's ownership of the property;

(5) The circumstances giving rise to the sale or exchange are not reasonably foreseeable when the taxpayer begins using the property as the taxpayer's principal residence; and

(6) The circumstances giving rise to the sale or exchange occur during the period of the taxpayer's ownership and use of the property as the taxpayer's principal residence.

in any case, you would first have to recapture any depreciation allowed or allowable during the rental period before any excess gain would be eligible for the exclusion if any is available under your circumstances.  

[Opus 17]

@gouriyashodhan 

Because the sale was less than five years after you bought the house but more than three years after you move out, you fall into a gray area and I do not know the answer.  The exclusion was not created to benefit landlords of rental property, it was created to benefit homeowners. My concern would be that you waited too long to sell for the sale to be considered the result of an unforeseeable financial hardship. I agree with the recommendation to get a professional opinion.