It used to be that you could convert a non-primary residence (rental or vacation home) into your primary residence, live there for 2 years, sell it and use the full home sale capital gain exclusion of $250,000 for single filers and $500,000 for married filing jointly couples.
This isn’t always the case today.
New tax provisions may make a part of the sale ineligible for the exclusion. Here’s what you must know.
How it Works
You must know how to calculate the part of your home sale gains that cannot be excluded. Here’s how.
- Calculate the total gain earned on the home sale but deduct any depreciation claims made on the property after May 6, 1997. This will go into your taxable income.
- Determine the fraction of the home sale that you cannot exclude. The numerator is the number of years after 2008 that your property was either a vacation or rental home (this is the time of non-qualified use).You don’t have to include times when you couldn’t occupy the property because of health or employment issues as long as they were temporary, short term and are for a total of less than 2 years. The denominator is the total time you owned the home.
- Take the amount from step 1 (gain you cannot exclude) and multiply it by the fraction from step 2.
- The amount calculated gets reported on Schedule D. You must also include any unrecaptured Section 1250 depreciation gain for any time after May 6, 1997. Any remaining amount can be excluded.
A Real-Life Example
John is married filing jointly and bought a rental property on January 1, 2000. He converted the property to a primary residence on January 1, 2015, and he lived there full time until 2020.
On January 1, 2022, John sold the property and made a $500,000 capital gain. This included $40,000 in depreciation deductions that he claimed during the time the property was a rental.
John reports the $40,000 on his tax return, which is subject to federal taxes. This leaves $460,000 in capital gains.
John owned the property for 22 years, of which 6 of those years are a part of the gains he cannot exclude. They are equal to (6/22 x $460,000) or $125,454. This is the amount John must claim on his tax returns as capital gains. The rest of the capital gains are excluded.
We know it can be confusing, but we’re here to help you determine which part of your home sale can be excluded from the capital gains taxes. Contact us today at 714-383-2307 to learn more.