New Section 121 Primary Residence Sale Exclusion Rules
IRS plans to increase taxes on some homesales.

New Section 121 Primary Residence Sale Exclusion Rules

There are new restrictions on Section 121 exclusions
involving the sale of your primary residence beginning
in January, 2009 . Did you know?

For many years now we have been able to exclude up to
$250,000 per taxpayer ($500,000 for joint filers) of
gain from a primary residence where you both lived
and owned two out of the last five years.

The rule is being modified beginning January 1, 2009
to provide for what is referred to as "nonqualified"
use in reducing the gain subject to exclusion.
Nonqualifying means any time a residence is not
used as the principal residence of the owner after
December 31, 2008. Thus, after that date rental or
second home use will be considered nonqualifying.
At least the new law provides that a period of
absence will generally count as qualifying use if it
occurs after the home was used as the principal
residence.

Gain is then divided between the periods of
nonqualified use and qualified use for tax purposes.
Here is how the calculation will be done--the time
of nonqualified use (beginning 1/1/09) while the
property is owned by you and is divided by the
total time owned by you. This fraction is multiplied
by the gain with the result is the portion to be
taxed at capital gains rates.

Example. You buy a property January 1, 2009,
for $400,000 and rent it for two years, claiming
$20,000 of depreciation. On January 1, 2011,
you start using the property as your primary
residence. You move out on January 1, 2013, and
sell it for $700,000 on January 1, 2014. The period
2009-2010 is non-qualifying use. But the year
after you moved out, 2013, is treated as qualifying
use. Of the $300,000 gain, 40 percent (two years
out of five years owned), or $120,000 is not
eligible for the exclusion. The balance of the gain,
$180,000, may be excluded. The $20,000 gain
attributable to depreciation is recaptured.

Example. Fred and Ethel, joint tax filers,
purchased a vacation property in 2000 for
$100,000. On January 1, 2011, they begin
using this property as their principal residence.
In 2020 they sell the home for $650,000.
Their total gain is $550,000. The number of
years after 2008 of nonqualified use is 2 (2009
& 2010). That is divided by the total years of
ownership 20 (2000 to 2020). Therefore the
taxable gain is 2/20 x $550,000 = $55,000.
The remaining $495,000 in gain is less than
the $500,000 exclusion under Section 121, so
they pay no income tax on that amount.

Hmm. Should Mr. Obama become President, this
will be the least of our tax concerns...

by Bill McKee - 10/08/2008

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