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IRS Says “Not So Fast” On 2 out of 5 Primary Residence Rule

Written by Diane Kennedy, CPA on May 2, 2018

One of the most misunderstood parts of real estate tax is the capital gains exclusion for primary residences that you have lived in for 2 out of the previous 5 years. It used to be just that simple. If you lived in a property 2 out of the past 5 years, you got to take either $250,000 of capital gains tax free (single) or $500,000 of capital gains tax free (married, filing jointly).

Quietly, the IRS has been changing the rules. Or maybe not so quietly, it’s just that there has been so much other news that than it’s been easy to have missed some of the changes.

There are three major changes. In today’s blog, I’m going to talk about what happens if you move into your former rental property.

First of all, you do not get to move into a former rental property and automatically get all the gains tax free as long as you’re under the capital gains exclusion amount.

The first change, which I think is a little better known is that you have to pay tax on the recaptured accumulated depreciation. So even if you normally would have had capital gains exclusion to cover all the gain, you still have to pay tax on the previous depreciation that you have taken on the property.

The second change has to do with the fact that it was rented before. You have to calculate the total gain first and then determine how much is applicable to the period that it was rented out past 2009 and how much was applicable to the years you lived in it.

Let’s say that you owned a property for 6 years. For the first 4 years you rented the property out. You then lived in the home as your primary residence for the next 2 years. You had a total of $150,000 of capital gains over the 6 year period.

However, you lived in the home for 2 out of 6 years since 2009, so only 1/3 (2 divided by 6) of the capital gains will be considered qualifying use. That means you have a capital gains exclusion of $50,000 (1/3 of $150,000). Of course, there is depreciation which also must be recaptured.

And, of course, there are some strategies you can use to maximize the capital gains exclusion. That’s just one little aspect of tax that has changed. Make sure you pick up your copy of “FIRST LOOK! Taxmageddon 2018” when it releases with a soft opening here on USTaxAid.com.

78 Comments

  1. Ken says:

    My wife and I
    1. Bought our only house in 1987 and lived there until 1994 and rented it until 2013.
    2. Sold the first house and bought another house through a 1031 exchange in 2013.
    3. Plan to sell it and buy a similar house through a 1031 exchange again in Q1 this year.
    4. Plan to rent it for two years and then live there many years as our primary residence but live there at least three years.

    Can we (joint filing) get the maximum exclusion if we sell the house in the step (3) above after five years?

  2. Diane Kennedy says:

    Great question, Ken. It brings up 3 different important law changes that people often forget and is too much to cover in a response here.

    I’m going to write a blog about it to post sometime from 1/22/21 – 1/24/21.

  3. Daine says:

    If you sell a home and still have a mortgage, say 60K left on your mortgage. Please confirm if my capital gains tax will only be based on the profit I’ve made from selling the house (i.e., after I’ve deducted the 60K still owed on the mortgage of the home.) I’ve lived in the house now worth 400K during the entire period of the mortgage for over 5 years.

    Also, how would this rule work on a duplex property you have a mortgage on if you’re living in one unit A and renting out unit B?

    Thank you in advance.

  4. Diane Kennedy says:

    Hi Daine:

    Your gain is calculated as the sales price minus your sales costs, minus you basis and minus improvements.

    So if it’s now worth $400,000, we would subtract the cost of sales, such as commissions and seller fees. Then we subtract the basis. Let’s say your cost of sales are $30,000 and your basis in the home (what you paid plus improvements) is $200,000.

    Your gain would be calculated as $400K – $30K – $200K.

    The amount of your loan doesn’t figure into the calculation for gain at all.

    I’ll answer the duplex question in a separate note.

  5. Diane Kennedy says:

    Daine,

    Question #2 from your post. What if you sell a duplex?

    In the case of a duplex (2 family home) you will need to divide up the basis and sales price. You end up with two separate calculations.

    Presumably, you’ve been depreciating the rented portion of the duplex, so you already have that basis.

    Then for the sales price, you need to divide the selling price. If the two units are absolutely the same, just divide it in two. If your home unit was fixed up more with a higher grade of materials, you may actually allocate more sales price to your own home.

    Let’s say the total sales price is $500,000 and they are exactly the same. Sales price is $250,000/ea. The basis was $200,000 again split exactly the same. There is also accumulated depreciation of $25,000 on the rental side. That has to be added back in the gain calculation.

    Cost of sales is $30,000 in total.

    So home gain is: $250,000 – $100,000-15,000 = $135,000 Rental gain is $250,000 – $100,000-15,000 +25,000 = $160,000.

  6. Charles Murray says:

    How does the IRS know for sure if you have lived 6 mo,, 1 dayi
    for at least 2 years out of the last 5 to avoid the capital gains tax? I assume they don’t do a bed check every night.

  7. Diane Kennedy says:

    If they call you into audit, you need to prove it. Could you lie? Sure. Just be careful what you post on open forums like this.

  8. Bought a house as primary residence in 1990.
    Lived in said house until 2004, became a rental.
    Last transaction on rental house was 2011, did a re-fi while married.
    Acquired said house Dec. 2013 through a divorce.
    Moved back into house Dec, 2017 as primary residence.
    Sold house in June, 2021.
    Am I eligible for $250,000. exclusion except for recapture depreciation.
    Will I not need Sale of Home tax forms due to exclusion?
    If so, what tax forms are required for recapture depreciation and how much depreciation is required since I was sole owner only since Dec. 2013.

  9. Diane Kennedy says:

    Hi Carmen,

    You will need to recapture the previous depreciation on Form 4797. Just a note, it is considered Section 1250 property for the rental property. (That confuses a lot of people!)

    From what you said, it sounds like you qualify for the exclusion except for depreciation.

  10. Gregg S says:

    I have a question about section 121 capital gain exemption on sale of primary residence. I bought a vacation home in Oct 2012, it became my primary home in March 2015 (I did not rent it out during the vacation home period, it was just my getaway). I sold the home in Oct 2021. So, it was my primary home for more than 24 months in the five years before I sold. When I fill out the tax form, it asks how many months since 2008(!) I used the house as something other than my primary residence. I enter in the time prior to using it as my primary, and it seems to prorate my exemption! No one mentions anything about this in any documentation I read. Am I doing something wrong? I expect the full exemption.

  11. Diane Kennedy says:

    If you received rent during that time after 12/31/2008 before it was your primary residence, you will need to prorate the amount of capital gains exclusion. If it was a second home and not used for business or rental purposes, than you do not need to prorate.

    IRS Publication 523 has information regarding the exceptions to the capital gain exclusion.

  12. Timothy Senak says:

    Hi Diane,

    Great advice; as always. Does it matter if we purchased on oceanfront condo in 2012 as a vacation home? We did rent it during prime seasons through a management company before we moved into it as our primary residence in 2017. We didn’t take depreciation at all since we purchased it, but do we need to pay on imputed depreciation recapture?

  13. Diane Kennedy says:

    Hi

    If you first rented it prior to moving into it, you’ll have to prorate the capital gain exclusion. So, let’s say you sell it now, in 2022. You would have 5 years as a rental and 5 years as a primary residence. If you’re married, filing jointly, that means you would have 1/2 of the possible capital gain exclusion available…. or 1/2 of $500K, ie, $250K.

    If you had depreciated the property while it was a rental, you will need to recapture that depreciation up to the amount of gain that you have.

  14. Mandie says:

    Bought house in 2003 and moved in.
    Rented it out 2008-April 2015.
    Moved back in April 2015.
    Sold it 2021.
    I know I qualify for the Capital Gains exclusion, but do I have to recapture the depreciation since it was my primary residence on the date of sale? If so, would this be on Form 4797?
    Thank you very much for any guidance!

  15. Diane Kennedy says:

    Hi Mandie:

    Yes, you will need to recapture all of that past depreciation.

    Thanks for your comments!

  16. Jon says:

    My wife and I both owned our own houses prior to being married 3 and 1/2 years ago. She’s had hers for about 30 years, and I’ve had mine for about 18 years. After we were married, she moved into my house. Her house has been empty with the exception of her adult son who has stayed there rent free off and on for a total of about 2 and 1/2 years. She’s been cleaning it out in preparation for selling it. Will the sale be exempt from capital gains?

  17. Diane Kennedy says:

    Jon, as long as she lived in the house for 2 of the previous 5 years prior to sale, she will receive capital gains exclusion.

    It sounds, though, that this won’t be the case for her. Even it closes today, going back 5 years would mean she had only lived there for 1 1/2 years.

    That would mean no capital gains exclusion.

  18. Donna says:

    Bought our property 12 acres and house in 1997, lived there until 2017 then rented it out until July 2021 when we decided we needed to sell due to financial issues (Self-employed and COVID impacted business).
    Out of the last 5 years, we did live in the house for 11months, can this be prorated?
    The house was rented out but not the acreage, does that make a difference on the Capital Gains?

  19. Diane Kennedy says:

    Hi Donna:

    You have two separate issues going on.

    First, do you qualify for any capital gains exclusion at all? If you need to be able to go back 5 years and show you have lived there for 2 years. From the details you gave, it sounds like that is not true.

    There is a possible “out” though and that’s if you qualify for unforeseen circumstances.

    See this blog:

    https://www.ustaxaid.com/blog/little-known-tax-strategy-if-you-sell-your-home-before-the-two-year-window/

    You will need to recapture depreciation and prorate the amount of capital gain exclusion. If you do qualify for unforeseen circumstances, you will have prorate twice. Once because it wasn’t 2 years and secondly because it was rented after 2009.

  20. Judith says:

    Hi Diane,
    I’m curious to know if the two years out of five rule means those two must be consecutive or can it be one year with a break for one year and then back in the primary residence for another year?

  21. Diane Kennedy says:

    Hi Judith:

    That’s an interesting question because it can get complicated.

    It is 2 years out of 5, and they don’t have to be consecutive.

    AND… you can have temporary absences away from your home. (Generally speaking, temporary absence is less than 12 months).

    So let’s say you own your home for 2 years. During that time you live in it for 6 months, then decide to take a cruise around the world for 4 months. During that time, your house is an AirBnB.

    You come back, live in your house for 3 months and then take a job in another state so you move there for 3 months. Your house is rented out during that time. You move back for 8 months.

    In total you’ve now owned this house as your principal residence for 24 months, or 2 years.

    You qualify for the 2 out of 5 years capital gains exclusion.

  22. Kevin Adams says:

    I have a question about a little bit different twist on the 2 out of 5 years. I am planning to purchase vacant land and build. As soon as I purchase, I will be claiming it as my primary residence and living in an RV on the property while building my home. If I decide to sell after residing “On the property” for over 2 years, can I take the exclusion, or do I have to base it on the CoO (certificate of occupancy) of the new home?

  23. Diane Kennedy says:

    Hi Kevin:

    I love this question! You do have a new spin on it. Technically, once you are living on the property, the 2 year clock starts ticking. After that, all you’re doing is improving the property.

    As long as you are living in the trailer you’ve put on the property, use that as your address etc… you have established residency. (And this assumes you don’t have any other residence)

  24. I’m selling my home to a buyer who wants me to take back a mortgage. He is paying a premium for the property so I’m inclined to do it even though the down payment is lower than I would like. My question pertains to the LTCG. The price will leave me with a gain, and my question is when is it owed? Is it the year I sell, or when the mortgage balloons in five years? thanks.

  25. Diane Kennedy says:

    Hi Lee:

    In most cases, you will be able to use the “Installment Method” to recognize the gain and pay tax on it over time.

    The interest will be taxable as interest income, but the principal portion of the payments will be partially basis and partially gain.

    For example, if you have a basis of $200,000 and sell the property for $400,000 (assuming no capital gain exclusion), then 50% of principal payments will be taxable.

    Let’s say in year one you collect $2,000 in principal payment and it’s 50% taxable. That means $1,000 would be taxable.

    Later when the note is paid off, the rest of the capital gains will be taxable.

    There is an exception if you are considered a real estate dealer. If that’s the case, then you cannot use the Installment Sale Method and it is immediately all taxable.

  26. Loretta Binfet says:

    Scenario:
    I am a resident of one state and in that state, I rent a twin home. For the winters I reside in another state for 5 – 6 months of the year. This is where I purchased a home where I intended to retire when the time came. Since then, plans changed, and I needed to sell that home and continue to reside in the state where I am resident. I have since then purchased a home. My questions: do I qualify to exclude the sale of the home? Do I need to pay taxes on the full capital gain?
    Thank you,

  27. Ken says:

    Hello,

    I purchased a home on October 20, 2020. I have a sale set to close on October 5, 2020. Can I use the exclusion if it’s not 2 years to the day?

  28. Diane Kennedy says:

    Hi Loretta:

    I’m not sure what a “twin home” means, but I’m going to guess this means that you rent part of a duplex or two party home.

    If I understand correctly, you live part of the year in a home you own and part of the year in a rental property.

    The first question will be where is your residency? Where do you file taxes, have your driver’s license, register to vote and spend most of the time?

    If it is in the state in which you own the home, then the next question is whether you have spent 2 out of the last 5 years with that as a residence.

    And finally, was the home you own ever a rental since 2009?

    Those will be the things to determine before you can answer the question as to capital gains exclusion.

  29. Diane Kennedy says:

    Ken,

    I’m not sure I understand your question. You bought the property October 20,2020 but then closed on it 10/5/2020?

  30. John Antanies says:

    Diane,

    Stumbled upon your website looking for something else. My side hack is real estate (own 15 properties in AZ and CO) but I have friends who owned 5 or so properties and subsequently moved into each for two years, then sold, ostensibly to claim the exclusion and not recapture depreciation.

    When did this change (pro-rating LTCG) go into effect? Did you always have to recapture depreciation?

    Personally, it is about time the IRS started cracking down on this behavior.

  31. Diane Kennedy says:

    Hi John:

    We have had to recapture depreciation on the sale for as many years as I can remember.

    The change as far as moving into previous rentals and then needing to pro-rate the appreciation came into effect 1/1/2009.

  32. Nancy Amundson says:

    Hi Diane,
    We have owned a 2nd home in Az for 20 years. Our primary residence is in WI. Every year we have spent anywhere from 3-6 months living in the AZ home. We had our mail forwarded to AZ and worked from our home there. We never opened a bank account in AZ though as there was no need. Last June we sold the AZ home and, as we have lived in the home for more than 24 months out of the past five years, I think this qualifies us for the 2 out of 5 rule when it come to capital gains on the sale. Our accountant is reluctant to do this – saying we might have a hard time proving it – since we never had a bank account there. How exatly are we supposed to prove it?

  33. Diane Kennedy says:

    Hi Nancy:

    There is a lot to proving residency. Some of the things that would be questioned include: What address you use on your tax return, where is your driver’s license, where are your cars registered, where are you registered to vote and, as mentioned, where is your bank account and investments.

    It’s too bad you didn’t have a little planning on this before the sale. You likely could have reduced or even completely eliminated the capital gains tax.

    It’s a good question that I’m going to cover in a blog soon.

  34. Lynn says:

    Hi, Diane,
    I purchase a property as primary residence and lived for a year and then I have to move to another state due to work changes. So I turned this primary residence into rental for 5 years. Then we decided to move back to live there for two years. Am I eligible for 2/5 exclusion?

  35. Bob Simonis says:

    We have a home in California and a short-term rental in Hawaii. If we use the short-term rental more that 14 days, it is my understanding that you have to pro-rate the expenses. When we rent the condo the expenses the additional expenses are about 90% of the gross rent since the revenue includes GET/TAT taxes, cleaning, and commissions. As a result, even personal days are expensive. It is our plan to stay in the condo a full year and then continue renting it the next year and after. I understand that we will have to recapture depreciation (you always do) and prorate any gains when we sell. How do we handle depreciation the year after we use the unit for a full year? Are there additional tax implications to consider?

  36. Diane Kennedy says:

    For Lynn:

    When you sell your property, you’ll need to go back 5 years. During that 5 year period, did you live in the house for 2 years?

    If so, you will qualify. Since you lived in the house first and then turned it into a rental, you don’t need to allocate the gain between rental and primary residence.

  37. Diane Kennedy says:

    Hi Bob:

    I’m sorry, I don’t follow the details. You have two properties, but I don’t know which is the condo.

    Can you provide information just on the property in question if the question is regarding depreciation? Or this may be a question that you need to discuss with a tax professional. Some tax questions are too complicated with too many moving parts for short responses on blogs.

  38. John Finnegan says:

    I was gifted property less than 2 years ago but lived at the property as a primary residence for over two years. Do I meet the 2 year holding period for gifted propery?

  39. Diane Kennedy says:

    Hi John:

    Although we frequently just say 2 out of 5 years, the IRS tells us that you must have lived in it and owned it for 2 out of the previous 5 years.

    The time limit would start once you own the property.

  40. Lynda says:

    My husband and I owned our old home for 20 years (2002-2022) and lived in it as our primary residence for 12 years (2002-2014), a gap for condo living (2014-2018), and then back to our old home for 26 months (2018-2020) prior to selling it in 2022. It was never a rental. When we weren’t living in it, it was vacant. Because we were not living in it at the time of the sale, we were given a 1099-S at closing and told we’d have to reconcile it ourselves on our 2022 tax return.

    We took full advantage of the home sale exemption when we sold our condo in 2018.

    QUESTION #1: Am I correct that we meet the ownership, use, and no exemption in the last two years criteria for taking the full home sale exemption for the sale of our old home in 2022?

    I have roughed out Form 8949, indicating Code H in Part II, Item 1, column (f) and -0- in column (h) because the adjustment in column (g) would negate the entire gain, which was less than $500,000 for married filing jointly. I transferred the Item 2 Totals to 1040 Schedule D, Part II, line 9 and then carried the line 15 Net long-term capital gain and line 16 Summary of -0- to 1040 line 7.

    QUESTION #2: Is there a form that I am supposed to complete to show the IRS our ownership and use dates?

  41. Diane Kennedy says:

    Hi Lynda:

    Count back 5 years from the date of sale. During that period, did you live in it for 2 years? If so, you have the exemption. It began as your primary residence, so you don’t have to worry about the proration.

    As far as how to report it, the IRS provides guidance here: https://www.irs.gov/taxtopics/tc701#:~:text=Reporting%20the%20Sale&text=Additionally%2C%20you%20must%20report%20the,to%20report%20the%20home%20sale.

  42. vince says:

    Sold my house that. I rented out the last 3 years and lived in it 12 years previous
    now my question is do I qualify for the exclusion and pay tax accumulated depreciation how much of the capital gains do I have to pay

  43. Diane Kennedy says:

    Hi Vince:

    If you go back 5 years from the sale date, did you live in it for 2 years? If so, you have some capital gains exclusion.

    Was it first a rental before you lived in it? If so, you need to allocate some of the gain to the period it was a rental.

    If you lived in it prior to being a rental, you don’t need to allocate.

    Just based on the info you gave, I’d assume that you get the full capital gain exclusion. Of course, you need to review your actual info with a tax professional to make sure the calculations are correct.

  44. Michael says:

    Hi Diane,

    I’ve owned and lived in my primary home with my wife for the last 5 years.
    We plan to rent it out for the next year.
    We would have approx. 500k in capital gains if we sold after that.
    Since I will have lived in the house for 5/6 years, would I only qualify for 5/6 (83%) of the 500k exclusion (415k)?

  45. Diane Kennedy says:

    Hi Michael:

    If you have lived in the house first and then rented it out, you won’t have to apportion the gain. The apportionment only happens if you rent first, and then live in it.

    It sounds like you definitely will qualify for the full $500K capital gains exclusion. You’ve lived in the house for 2 out of the previous 5 years (even if you rent it for several years now). You and your wife haven’t sold any other primary home and taken the capital gain exclusion in the past 2 years.

  46. Michael says:

    Thank you for the quick reply.

    I have talked with another CPA and they were under the assumption that there is “qualified” and “non-qualified” use of the property and it didn’t matter which came first and thus, you had to apportion the gain.

    Its nice to hear thats not the case.

  47. Ron says:

    Hi Diane.

    My wife and I have owned our house from 30 plus years. We started being snow birds a few years ago. Bought a 2nd home in AZ. We spend 7 months in our AZ home and 5 in our original MN home each year. We have rented the MN house for some of the months we were away.

    We changed our residency to AZ because we understood we needed to, due to spending more time there. We pay AZ state tax, drivers license changed to AZ as well. We have bank accounts, doctors, etc in both states.

    We want to sell our MN house which has a $350k gain on it.

    1. Do we qualify for the exemption, because we live there 5/12 out of every year, so more than 24 months out of 5 years? My concern is you had responded earlier to someone about their residency being a concern. Is our residency in AZ a problem?

    2. We may be interested in selling the house with a contract for deed or provide a 2nd mortgage to help us sell our house. I know you said earlier in this case we qualify for an installment sale and consider the gain on the capital received each year. I don’t want to qualify! I want to claim the entire amount in order to get the $350k gain excluded.

    Isn’t this possible? It seems strange to penalize us because we need to offer a CD to sell our house because interest rates have gotten so high.

  48. Diane Kennedy says:

    Hi Ron:

    Residency is determined by a number of factors. You can’t have part of one year for one state and part of the same year for another state, year after year.

    Let’s assume you sell your MN house on 9/1/2023. If you go back 5 years, were there 2 years in that time period where you had a MN driver’s license, cars registered in MN, and filed your tax return as a MN resident?

    That’s the simplest way to look at this. If you filed your tax return as an AZ resident during that whole 5 year period, you don’t have a capital gain exclusion. If you do have 2 years that you did file as a MN resident, you do have an exclusion.

    There could also be some extenuating circumstances that may qualify (death, disability, change in the family, etc) as a justifiable reason why you don’t have the full 2 year time. You would then get to take a small capital gain exclusion. That would be something to discuss with your tax professional.

  49. Ron says:

    Can you answer the question about selling via Contract for Deed? Do we have to do the “Qualifying” for deferred gain, or can we claim the entire gain this year and use the exemption? We would need to sell this year on order to have the 24 months of MN residency in the last 5 years, and the only sale I can get now is through a contract for deed.

  50. Sue Oliver says:

    We lived in our primary home in 2010 until now, Sept 2023. We intend to sell by the end of this year then purchase a primary in another state. Can we claim the 500K exclusion?

    We sold our rental property in 2021. Not sure if this affects our claim for exclusion when we sell our current primary end this year.

    This 2/5 years is confusing to me. I am interpreting it as we have to sell 5 years after the home being primary to be eligible for the exclusion but reading the previous comments, it seems that you can live longer than 5 years as long as you have lived in it for 2 years minimum. Is that right?

    Thank you so much for this forum. You are helping a lot.

  51. Diane Kennedy says:

    Hi Sue:

    The way the 2/5 year rule is you go back 5 years from when you sell. Let’s say you sell it in October 2023, So from 10/18 – 10/23, did you live in the house for at least 2 years?

    The answer is “yes” and so you get the gain exclusion! Married, filing jointly is $500K of gain that is excluded.

    As far as the rental property you sold, that’s a separate deal. Unless you did a like kind exchange, you likely paid tax on the gain in 2021.

    Once you buy another primary residence, the 2/5 clock starts running again. Or if you never buy and just rent, that’s okay too.

  52. Min says:

    Hi, Diane, thank you for helping with questions. I lived on one side of a duplex and my son lived in other side starting August 14, 2020 as our primary residence. We then moved out in January and the duplex was made available to rent on February 5, 2022. As you can see, we only lived there for 1 year and 5 months. If I sell my duplex around January 1, 2024, does the 2/5 rule still apply? Or do I have to have owned the property until September 2025 for it to apply? Thank you.

  53. Diane Kennedy says:

    Hi Min:

    You wouldn’t have lived there for 2 years, so unless you qualify as moving due to unforseen circumstances, you don’t get any gain exclusion.

    If you moved back in for 7 months, you would qualify.

  54. Ed says:

    My wife and I are selling a co-op in NYC. I purchased the co-op in 1999, and we started occupying our new home in May 2020, though our voter registration didn’t occur until October 2020. The apartment has sat vacant since then, being used as needed when we were in the city. It has never been rented.

    Would we qualify for the cap gains exemption?

    If not, since I held the apartment for over 20 years and our gross income filing jointly is just under $200,000, what would be the cap gains rate for the sale?

    Thanks!

  55. Diane Kennedy says:

    Hi Ed:

    I’m not quite clear on your primary residence usage from your question.

    What dates was this co-op your primary residence? If it was a second home only, then there is no primary residence capital gain exclusion.

  56. Ed says:

    Hi Diane,

    The co-op was my primary residence from September 1999 thru May 2020. At no time was it ever rented. Because of COVID-19, in May 2020 we started staying in the home in which we currently live, and kept the apartment for occasional use, like weekends in the city.

    We registered to vote in the house’s county in October 2020, and our driver’s licenses were issued in 2021 and 2023. From what I understand these are two documents that help to establish primary residence.

    We’re looking to sell the co-op as soon as possible. Would we be hit with capital gains, and if so, what would be the rate?

    What would officially constitute using the house as a primary residence?

    Thanks so much,
    Ed

  57. Robert A MacPherson says:

    My wife and I bought a second home in Michigan in September 2009 that we rented out during the summers for a few months in each of 2012 and 2013. We sold our primary Ohio residence in June 2014 and eventually moved to the Michigan home in May 2015. We sold the Michigan home June 2023 realizing a gain of $460,000. How do I calculate the gain allocation.

    Thank you for your insight.

    Bob

  58. Diane Kennedy says:

    Hi Bob:

    It sounds like the MI property was a 2nd home from 9/2009 – X/2012, rental from x/2012 – y/2013, 2nd home y/2013 – 5/2015, and primary residence 5/2015-6/2023.

    I know that sounds like an Algebra problem, but it is a little easier.

    Calculate how many months it was a rental, how many months it was a second residence and how many months it was a primary residence.

    You clearly pass the 2 out of the past 5 years rule for capital gain exclusion. The period from x/2012 – y/2013 will be the rental period. It’s from the beginning of rental status to the end of rental. I’m assuming it was up for rent during the whole time.

    Calculate your total months owned and divide it into the rental period versus 2nd home + primary residence. The percentage of rental period will be applied to either the capital gain exclusion of $250K (single) or $500K (married filing jointly) to reduce the amount.

    If you depreciated the property, you’ll need to recapture that no matter how much the exclusion is.

    If you want to post the # of months it was rented, # of months you lived in it as a primary and # of months it was a second home, I can show you the formula. (Please don’t make me count months)

  59. Kelly says:

    Joint ownership of rental property. If only 1 party moves into it for 2 years as principle residence & sell, do we avoid capital gains? Or do both parties have to move.

  60. Diane Kennedy says:

    Hi Kelly:

    There could be some other factors that might change this answer (such as disability, separation, temporary absence, etc) but the general rule in that case is that the capital gains exclusion will be half ($250,000) that of married filing jointly.

  61. Pramod says:

    Hi Diane,
    I bought a house in June 2019 and lived till Aug 2023 and moved to new home in Aug 2023. I gave first home to rental.

    how to qualify for 2-in-5 year rule and how much time do I have left to sell first home to avoid capital gains tax.
    when is 5 year period come to picture ? date purchase of my first home or second home?

    thanks

  62. Diane Kennedy says:

    Hi Pramod:

    You will need to count back 5 years from when you sell the house. So, let’s say you sell it 6/2024. Five years back is 6/2019. During that time, did you live in the house for at least 2 years?

    The answer is “yes” so you would qualify for the $250K exemption if you’re single or $500K if you’re married, filing jointly.

    Just do that calculation for whenever the house sells.

  63. Jennifer Tyson says:

    Good evening, Diane. I took a job a couple of years ago that required establishing a residence close to my customer’s HQ location in another state. I closed on that second home in April of 2022. My husband was reluctant to move as he had started a new job at the same time, so I have officially been a dual resident ever since. One month in 1 state, one month in the other is the established cadence that gets me here often enough for my customer and gets me home enough to not get divorced (haha). Do I need to maintain ownership of this property until April of 2026, then? Also, I never changed my car registration, bank accounts, or anything else because I didn’t need to. I never rented either property nor intend to. Are there other considerations I should be aware of just to prepare for the eventual sale of this second home? Thanks so much for your advice!!

  64. Diane Kennedy says:

    Hi Jennifer:

    The question will be whether you have established residence in the new state. If you file as married filing jointly, then you have not. The second home is just a second home or a temporary assignment. Neither would qualify for the capital gains exclusion.

    If you legally separate or file as married filing separately, you may have a separate residence. But please talk to your tax professional first, this can bring up other unintended tax consequences.

  65. Yvonne Gail Miller says:

    I lived in my moblehome for 6 yrs or more, i just sold it for 80,000 and cleared 69,000 after fees. I had to sell to move in with my mom to take care of her..
    Do i have to pay taxes on this?

  66. Diane Kennedy says:

    Hi Yvonne:

    I’m assuming that this was your primary residence. Normally, I’d ask you what the gain was on the sale but since you have an exclusion of at least $250K, that will cover any possible gain.

    So if it’s your primary residence, there is no capital gains tax due.

  67. Sue Ellen says:

    1- Bought home with 5 acres 1985. Paid off. We have changed deed to a Lifetime exemption with 2 children listed as heir approx 5 yrs ago. Have lived in house the since 1985.
    2- Bought adjoining 9 acres and house approx 5 years ago, from family member. Have done major work there. Mortgage in our name. 1 child lives there at no charge. We have the deed with Lifetime Exemption with his name as heir.
    Questions- A–On our passing, what type of taxes would they be responsible for? Capital Gains? Inheritance, etc? Does it go back to day #1 of US purchasing the properties.
    B– When we do OUR taxes, can we take off interest, property taxes, expenses (repairs, etc), energy credits for property #2. If not, can the 1 child take off ?
    C- Can we claim the Property taxes, etc for #1?
    Thank you so much!!

  68. Diane Kennedy says:

    Hi Sue Ellen:

    I’m not sure what the “lifetime exemption” is that you are referencing. If this is referring to gift tax, please talk to your estate attorney or tax professional who helped you with that filing. There could be other factors involved and it’s not within the scope of this blog.

    There is no “lifetime exemption” for the capital gains exclusion, which was the topic of the blog.

    I would need to understand first what kind of filing you did before I could answer your question. My guess is that it’s something unrelated to the capital gains exclusion.

  69. Eliz says:

    Hello purchased a home in 9/2018 then left on and off on 9/2021. Rented one year and half and now I want to sell. I would assume I have the 2 years and what else should I subtract from the capital gains besides de 5% that the realtor is asking?

    Thank you.

  70. Diane Kennedy says:

    Hi Eliz:

    You first need to determine if you qualify.

    #1: Go back 5 years from when you sell. Let’s say you sell on 6/1/2024. Five years back is 6/1/2019.

    #2: During the time period 6/2/2019 – 6/1/2024, did you live in the house for 2 years? This would need to meet the qualifications of “living in” with drivers license, cars registered, where you filed your taxes, etc…

    #3: If so, then yes, you have the capital gains exclusion. If no, then you don’t unless you meet one of the exceptions.

    If you have a capital gains exclusion ($250K if you’re single or $500K if you’re married filing jointly), you don’t pay tax on the sale.

  71. Phil says:

    We have two house properties in CA ~120 miles apart. Never rented out. Owned jointly.
    Spend 50% of the time together at each property since retiring more than 15 years ago.
    Receive mail at both properties but taxes, car registration, DL, voter registration and most mail is sent to property A. Want to sell property B and claim capital gains exemption. We have resided in property B for 50% of the time so it seems we meet the 2 out of 5 year requirement but since we haven’t established “residency” for property B’s address (taxes, car registrations, etc.) do we need to do this before we can start our 2 year clock? If so, what steps must be taken to begin the 2 year clock? Otherwise, what proof do we need to show that we spent 50% at each property?

  72. Dianne says:

    In January 2024 we just started to rent out our home we had as our primary residence since 1996. Assuming we do not move back in, would we need to sell by January 2027 to avoid all capital gains?
    Also, we moved out of the house in October 2023. Is it considered a rental immediately in October when we moved, even though we did not have a tenant or attempt to have one until January?

  73. Clyde says:

    My wife is originally from Peru, her grandparents gifted her a house a long time ago prior to her becoming an American citizen and now she is ready to sell it. Will she need to report capital gains taxes on the sale of a property that she owned prior to being a Citizen?

  74. Diane Kennedy says:

    Hi Phil:
    Check out the Braggs test at the end of this blog. It discusses CA, but the Braggs test is a legal test, not just a CA one.

    https://www.ustaxaid.com/blog/make-sure-your-old-state-knows-you-moved-when-it-is-tax-time/

  75. Diane Kennedy says:

    Hi Clyde:

    There are some more complicated issues with your wife’s cross border tax situation that go beyond the scope of this blog.

    Please consult with a tax expert who is familiar with treaties and international tax. I stopped doing that area of my practice about 5 years ago, so I’m not longer current and can’t give advice.

  76. Diane Kennedy says:

    Hi Clyde:

    There are some more complicated issues with your wife’s cross border tax situation that go beyond the scope of this blog.

    Please consult with a tax expert who is familiar with treaties and international tax. I stopped doing that area of my practice about 5 years ago, so I’m not longer current and can’t give advice.

  77. Jennifer says:

    Purchased home Jan 1, 2021 for $250,000
    Lived in home 2 years (2021 and 2022)
    Rented home 2023, Plan to rent home 2024 and 2025 (so 3 years)
    Plan to sell home at end of 2025 and buy my forever personal home with the proceeds.

    Questions:
    Does the 2 out of 5 year rule mean I am completely excluded from having to pay capital gains taxes?
    If not, how is the capital gains taxes calculated?
    Should I take the annual depreciation deduction for the 3 years it is a rental property? Or will that hurt me from getting a full exclusion of capital gains.

    Thank you!

  78. Diane Kennedy says:

    Hi Jennifer:

    If you sell by 2025, it looks like you will have the 2 out of 5 year gain exclusion.

    The amount of exclusion is $500K if you’re married filing jointly or $250K if you’re single.

    If you have taken depreciation, you will need to recapture that and pay tax on it.

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