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Congress
Limits Gain Exclusion
on the Sale of Some Primary Residences
When Congress passed the Housing Assistance
Act of 2008, their goal was to help those people who
were losing their homes in foreclosure. One of the
side effects of the bill, however, was a change that
could affect taxation on the gain from the sale of
YOUR personal residence.
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by Gary Gorman
founding partner, 1031 Exchange Experts, LLC |
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If you sell a primary residence you’ve
lived in for at least two years, section 121 excludes
$250,000 of the gain from taxation if you’re
single and $500,000 if you’re married. This is
true even if a portion of the gain was rolled over
into the property in a 1031 exchange transaction. For
example, if you and your spouse sold a rental property
in Kansas, bought a property in Vail, rented it out
for several years and then moved into it as your primary
residence for a couple of years, your excluded gain
could include gain that was rolled over in your exchange.
This new law modifies that rule and
penalizes you for the time that your property was not
your primary residence; you effectively have to prorate
the gain between the period that the property was not
your primary residence and the period that it was.
(Your primary residence is the place you live; the
address you use on your drivers license; where you’re
registered to vote, etc.) Only the non-residence period
after January 1, 2009 is excluded. So, if you bought
or exchanged into a property on January 1, 2007, rented
it for three years, moved into it on December 31, 2009,
then lived in it for another three years until you
sold it, you would have owned the property for six
years: three of which it was a rental and three of
which it was your residence. However, since only one
of the rental years was AFTER January 1, 2009, the
numerator in your calculation would be ‘1’ (the
number of rental or non-residence years after January
1, 2009), and your denominator would be ‘6’ (the
total number of years you owned the property). In other
words, 1/6 of your gain would be taxable: if your total
gain was $300,000, then $50,000 of that would be taxable,
even though you would otherwise be entitled to an exclusion
of $500,000.
I say the NON-RESIDNECE period rather
than the RENTAL period because it’s not necessary
that you actually rent the property – the law
deals with the period that the property is your residence
and the period that it is not. In my example above,
if the Vail property had been your vacation home instead
of a rental for the three years before you moved into
it, and then it was your residence for the next three
years, the result would be exactly the same: $50,000
of taxable gain out of a total gain of $300,000.
The new law only covers those situations
where the rental period or vacation home period falls
before the primary residence period. It does not cover
situations where it was your residence first, and then
became a rental property. This was done so that homeowners
who were forced to rent their former residence while
they tried to sell it would not be penalized.
As time goes on our questions about
this new law will be answered by court cases or IRS
rulings (such as, “what happens if you build
a house on a piece of bare land that you’ve owned
for years?”). But my advice is if you are planning
to move into your current rental or vacation property
at some point in the future, you should do so as soon
possible.
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