Amendment to Homeowners Exclusion
| Read comments | Add comment / Rate this Article | Article by: Whitney Brennan |
One approach for Taxpayers to mitigate paying capital gains taxes on the sale of investment property has been to convert the investment property into a primary residence and later sell it to take advantage of the Homeowner’s Exemption under Section 121 of the US Tax Code. A taxpayer can exclude up to $250,000 ($500,000 for married couples filing jointly) of gain realized on the sale of a primary residence if the Taxpayer has owned and occupied the property for two years out of the five year period preceding the date of sale. (Gain related to depreciation deductions taken after May 1997 is not eligible for the exclusion). Until the end of 2008 – Conversion of Investment Property to a Primary Residence (the Taxpayer must own for five (5) years and live in property for two (2) years). The Housing Assistance Act of 2008 signed by President Bush on July 30, 2008 includes a modification to the Homeowner’s Exemption under Section 121 that makes the above strategy less effective. Starting January 1, 2009, the new exclusion will not apply to gain that is allocated to periods of non-qualified use. Non-qualified use refers to the periods that the property was not used as the primary residence. Effective January 1, 2009 – Tax Benefits of Section 121 will be prorated if one converts Investment Property to a Primary Residence.
- Taxpayer acquires Investment Property in an exchange in 2009 for $100,000
- Taxpayer rents the property for three (3) years – 2009, 2010 and 2111
- Taxpayer moves into property as a Primary Residence for two (2) years – 2012 and 2013
- In January 2014, taxpayer sells the property for $600,000
- Taxpayer (married couple) gets a 2/5 exclusion (or $200,000) because years 2009, 2010 and 2111 were considered non-qualified use since the property was not used as a Primary Residence.
Possible scenario if one converts an Investment Property held prior to the Amendment’s effective date
- Taxpayer exchanges into an Investment Property in 2007 for $100,000
- Taxpayer rents the property for three (3) years – 2007, 2008, and 2009
- Taxpayer moves into property as a Primary Residence for two (2) years – 2010 and 2011
- In January 2012, Taxpayer sells the property for $600,000
- Taxpayer (married couple) gets a 4/5 exclusion or $400,000 because:
- 2007 and 2008 are qualified use (before Amendment)
- 2010 and 2011 are qualified use because the property was used as a Primary
- 2009 was non-qualified use because the property was not used as a Primary
- 2007 and 2008 are qualified use (before Amendment)
The decision to Exchange will depend on each individual’s situation and tax liability. Ultimately, a taxpayer should consult with his tax specialist and legal counsel.
This information is not intended to replace qualified legal and/or tax advisors. Every taxpayer should review their specific transaction with their own legal and/or tax counsel.
