Little Known Tax Strategy If You Sell Your Home Before the Two Year Window | USTaxAid

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Little Known Tax Strategy If You Sell Your Home Before the Two Year Window

Written by Diane Kennedy, CPA on February 12, 2022

One of the best tax breaks available for homeowners is the capital gain exclusion. If you live in your home for 2 of the previous 5 years (and meet some other requirements), you can exclude $250,000 of gain (single) or $500,000 of gain (married filing jointly). 

There are some other variations to the rule if you’re divorced, recently married and your spouse had taken the exclusion and if you move into a property that had previously been a rental.

Today, though, I want to talk about a tax strategy that can get you a capital gain exclusion even if you don’t live in your home for the minimum of 2 years. 

The exclusion is known as “unforeseen circumstances.” 

Unforeseen Circumstances Can Give You an Unexpected Tax Break

The IRS allows a special allowance if you have to move from your home before you meet the minimum 2-year standard.
If you, your spouse, co-owner of the home or anyone else for whom the house was a residence: 

  1. Have died,
  2. Became divorced or legally separated, 
  3. Gave birth to 2 or more children from the same pregnancy, 
  4. Became eligible for unemployment compensation, 
  5. Had a change in employment status and as a result need to change cost of living expenses, and
  6. Other unforeseen events that necessitate a move by the taxpayer.

The last one, (6),  can be pretty subjective. The IRS seems to have been more lenient lately in defining what other qualifying unforeseen events may be. Some recently allowed events were: 

  • A family moved after discovering the home they’d bought was in a dangerous, crime-ridden area. One of the taxpayers and their child was assaulted. So it was a serious concern. The IRS allowed the shorter stay. 
  • A family moved to keep their children in the same school district. They planned to move back into their old home eventually. When they did, they discovered it was too small. The IRS allowed the “unforeseen event” argument for less than 2-year stay.
  • A couple lived in an age restricted retirement community and had to sell when their daughter and grandchild moved in with them. The IRS allowed the shorter stay for the capital gain exclusion. 
  • A taxpayer had to sell her home because her health had taken a rapid decline and she needed to move into a nursing home. The IRS allowed the shorter stay. 
  • Couple had a 2 bedroom house, with one bedroom used as a home office for husband’s work. They had a baby and needed to move to a larger home to accommodate the baby’s room and an office, in addition to the master bedroom. The IRS allowed it. 

Calculating the Unforeseen Circumstances Capital Gain Exclusion

If you meet the criteria for unforeseen circumstances, you can get some of the capital gain exclusion when you sell. Otherwise, without this special tax strategy, you wouldn’t get any exclusion until you had lived there (and owned) the property for at least 2 years. 

The amount of gain exclusion is calculated by determining how much of the 2 years you lived in the property. 

For example, let’s say you had lived in the home for 20 months before you sold the property. The property had a gain of $200,000. You have a capital gain exclusion of 20/24 x $250,000 (assuming you are single) or $208,333. Since your gain is $200,000 and that is less than the pro-rata portion of the possible gain exclusion, you will be able to exclude all of the gain. 

In another example, let’s say you are still single ($250K exemption, at the most) and you have $300,000 worth of gain. If you lived in the property for 24 months, you’d have $250,000 of gain that is tax free and pay tax on the difference of $50,000. If you lived in the property for 20 months, you’d have $208,333 of capital gains free income. The difference of $91,667 is taxable. 

What’s Next?

Tax planning is always best done in advance. Don’t ask about the unforeseen circumstances after you’ve sold your property. Talk to an experienced CPA first and then plan how to minimize your taxes.

There are several ways you can work with our firm. The most efficient way to get an answer to your tax questions by a qualified tax professional is by joining our Wednesday Coaching session. We meet the 1st – 4th Wednesday nights at 5 pm Pacific. If you can’t make the session live, it’s recorded. We’ll also have Home Study Courses for the 1st – 3rd Wednesdays. Join us!

One Comment

  1. PATRICK SHEEHAN says:

    Looks interesting is there a cost involved.

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