New 2013 Rules For Selling Your House For No Tax


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house sell taxIt’s March 2014, and I was shocked at something I found on the Internet today. There are lots of articles about how to sell your house for no tax. And unfortunately, 90% of them are wrong.

In fact, “Real Estate Loopholes” which I wrote back in 2004, is wrong too.

That’s why it is so important to make sure you’ve got correct and up-to-date information.

Here’s what’s wrong:

If you live in your house for 2 of the previous 5 years and sell it for gain, you can exclude up to $250,000 of gain if you’re single or up to $500,000 of gain if you’re married filing jointly.

That all changed January 1, 2009.

Let me say it again, if you’ve been told that all you need to do to get a capital gain exclusion is live in your house for 2 of the previous 5 years, than you’ve got old advice.

Here’s how it works.

You still get the exclusion if you lived in your house for 2 of the previous 5 years, with one exception. There can’t be any non-qualifying use.

Non-qualifying use means that the property is not being used by a primary residence by either the taxpayer or the taxpayer’s spouse.   It means that the property might have been rented out, used as a vacation home or used as a second home.

You can have absences from the house and it won’t count as non-qualifying use as long as the aggregate doesn’t exceed 2 years in the 5 year period.  And of course, you need at least 2 years of qualifying use.

If you do have non-qualifying time in your house, you’ll need to do a calculation to see how of the gain you’ll have to pay tax on.
Divide (period of non-qualifying use) by (total period of ownership)

The property still can maintain its status as primary residence if an owner is absent due to a change in employment, health conditions or unforeseen conditions. We now have a pretty clear list of what is and what is not unforeseen conditions, so check with your CPA if you think this might apply to you.

Let’s look at an example.  Let’s say you buy your property January 1, 2010. You sell it January 1, 2014, after owning the property for 4 years. For 2 years, you lived in the home. And for 2 years, you rented it out.

Assuming you don’t meet any of the other qualifications, you’ve got a ration of 50%. That means when they sell the house for a gain of $100,000, half of the gain will be taxable. That’s true even though the $100,000 is way less than the normal exclusion of $500,000 for a married, filing jointly couple.

There are some lessons in all of this:

  1. Don’t trust what you read on the Internet. That’s ironic considering that you’re reading this warning on the Internet. Maybe a better way to say it is to make sure you can trust your sources and that the information is current. Look for dates on posts!
  2. Plan ahead with current information. In the example above, if they had rented the house for one day less, all of the gain would have been tax-free. Strategy works, but only if it’s in advance.
  3. Make sure you use the best advisors you can afford. Free advice is often the most costly advice you can get.

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One Comment

  1. Rong says:

    Diane,

    I have been enjoying reading your blog.

    However, I have slight disagree with you on this. The example you mentioned (2 year as home followed with 2 year rental) is exactly like the example 2 at page 16 of IRS Publication 523 (2013). In this case, you are allowed full exclusion because “the period of nonqualified use does not include any part of the 5-year period after the last date you lived in the house”, therefore there is no period of nonqualified use.

    If the case is changed to moving back to the house after renting it out 2 years, the 2 years rental period will be considered nonqualified use, just like the example 1 at the same page of IRS publication.

    Am I understanding the IRS rules correctly?

    Thank you and love to join your seminar and read your articles.

    Regards,
    Rong

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