[1128434]

Chris and Jennifer purchased their home in California on January 15, Year 1, for $160,000. During their ownership they made no capital improvements. On August 1, Year 4, the couple moved to Virginia from California and rented out that home. On June 30, Year 6; the couple contracted to sell the California rental home for $437,500. For the calendar Year 6, the couple will file a joint tax return. Disregarding any depreciation recapture rules, how should they treat the sale of the home for tax purposes?

Answer: Realized gain of $277,500; not taxable due to the home exclusion. Disregarding any depreciation recapture, Chris and Jennifer have a realized gain of $277,500. For tax purposes, this gain will not be recognized on their Year 6 tax return as it is excludable under the Homeowner’s Exclusion. To qualify for the full exclusion of $500,000 for a joint return, the taxpayers must own and use the home as the principal residence for two years out of the five- year period ending on the date of the sale or exchange (and may not have any unqualified use after 2008).

My question is why those months the couple rented their house out no need to prorate the gain? Because I think it is nonqualified use provision for their home.

[CPAIN2K17]

If you read the solution, to qualify for the full exclusion they just have to own and use the home for two out of five years preceding the sale. They lived there for over three years of the preceding five years, so they get the full deduction.

[1128434]

@CPAIN2K17 If they did not live there for 2 years or more during 5 years period, the gain will not be deducted and there is no need to prorate the nonqualified part. I feel like nonqualified provision is for those people who already meet 2 out of 5 years rule, but some of the months they rent their house out then the gain allocated to those months are recognized

[SA]

I'm actually curious about this, too. It doesn't make sense to me that part of the gain would be ineligible to be “hidden,” because there were two years of unqualified use (the renting out of the house while living in Virginia).

Can anyone else shed some light on this?

Is it because they already had two years of established use (i.e., lived in the house for two years) before renting it out for two years and then selling? The example in the lecture has one year of living in it, two years of renting it, then one year of living in it again before selling, so maybe that's the difference?

Or does it have to do with the fact that the question in the OP had > 5 years owned by the couple, whereas the example in the book (1 on, 2 off, 1 on –> sell) has only 4 years of ownership?

[SA]

Bump.

[SA]

I think I just figured it out. There's no reduction in the homeowner's exclusion for the question in the OP because the non-qualified use period does not include any time after it was last used as a primary residence.

So if they had moved back into the house for a year before selling (vs. selling remotely), the period of non-qualified use would be factored in and there would be a reduction in the homeowner exclusion available to the couple.

[Author]

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