There is a new law that goes into effect on January 1st, 2009 which will affect the amount of gain that you can exclude on the sale of your primary residence.
Currently when homeowners sell their main home, they can exclude up to $250,000 from the gain, or $500,000 if married filing a joint return. The only requirement is that they must have owned the home for at least 2 years and they must have lived in the home for at least 2 of the past 5 years. The Housing Assistance Tax Act of 2008 changes those rules. The amount of profits from the sale of a house that can be excluded will now be based on the percentage of time when the house was actually used as a primary residence.
Homeowners who sell their primary residence can still exclude up to $250,000 (or up to 500,000 for married couples filing jointly) in capital gains from their taxes, but the amount of gain that will qualify for the exclusion is limited based on the amount of time that the house is actually used as a primary residence.
If the house is used other than as a primary residence, capital gains must be allocated between qualifying and non-qualifying use. Any non-qualifying use can potentially reduce the amount of capital gain that can be excluded.
Under the new rules which go into effect on 01/01/2009, you will still need to meet the requirements of having owned the home for at least two years and having lived in the home for at least 2 of the past 5 years - that part does not change. However, if you have not lived in the home the entire time that you owned it, then you will only be allowed to claim a prorated portion of the exclusion amount based on the percentage of time you actually lived in the home.
As an example, if you owned a home for 2 years and lived in it for the entire 2 years, you can take the entire amount of the exclusion. However, let's say that you owned the home for 5 years, and lived in the home for 2 years as your primary residence, and then rented out the home for the other 3 years, then you would only be allowed to claim 40% of the exclusion amount - based on the fact that you lived in the home for only 40% of your total ownership period. So the amount you could exclude from your gain would be $100,000 for single taxpayers and $200,000 for those who are married filing a joint return.
I am giving you a link below to an article which explains the new rules in "plain English" so to speak. The IRS code on this is pretty complex, and I do not believe that the IRS has yet put out a Publication which explains these new rules, but the article below should help.
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