Have a Tax Question? Ask a Tax Expert
Sale of residence that was formerly investmentproperty – the taxpayer is entitled to only a pro-rated portion of the $250,000/$500,000 exclusion.• Non-qualified use prior to January 1, 2009 is disre-garded, except for purposes of meeting the 5 yearrule under HR 4520, if applicable1• Gain resulting from depreciation is taxed and isdisregarded for purposes of determining the pro-rated amount of the exclusion
This is a result of the amendment to rule 121, effective Jan. 1 2009
Maybe an example will help:
Taxpayer acquires an investment prop-erty, rents it for 3 years and then occupies it for 5years as his principal residence (no use prior to 2009)before selling it and realizing $350,000 of gain ofwhich $40,000 is from depreciation deductions.$40,000 of gain is depreciation and is excluded fromthe calculation. The remaining $310,000 is subject tothe prorata calculation as follows:
3 (years of non-qualified use) = 3 (37.5%) x $310,000=$116,2508 (years total ownership)8Thus $116,250 is not eligible for exclusion and istaxed at the applicable capital gains rate. $40,000 ofgain is from depreciation and is taxed at the applica-ble recapture rate. The remaining gain of $193,750may be excluded from taxation under §121.
Here's another one:
Taxpayer acquires an investment prop-erty in 2007, rents it until 2010, and then occupies itfor three years as his principal residence before sell-ing it in 2013, realizing $400,000 of gain. The twoyears prior to January 1, 2009 are disregarded (butincluded for determining the five year period).1 year non-qualified use(disregard 2007, 2008) =6 years of total ownership1 (16.66%) x $400,000=$66,6406Thus, $66,640 is not eligible for exclusion and istaxed at the applicable capital gains rate. $250,000 ofthe remaining gain may be excluded under §121, withthe balance of the gain, $83,360 taxed at the applica-ble capital gains rate. In sum, $250,000 is not taxedand $150,000 is taxed.Taxpayers selling a principal residence afterJanuary 1, 2009, which was formerly used as aninvestment/rental property should consult with theirtax or legal advisors regarding the application of theamendment to §121 to their particular situation.