IRS has provisions for homeowners regarding the sale of a principal residence that allows for temporarily renting the home without losing the ability to exclude the gain if the home is sold under the correct conditions.
The rules for the exclusion of gain on the sale of a principal residence are:
- Up to $250,000 of gain may be excluded for single taxpayers and up to $500,000 for married taxpayers filing jointly.
- Ownership and Use must have been a principal residence for two of the five years preceding the date of sale (closing date). This allows for a temporary rental for up to three years maximum.
- Either spouse may meet the ownership test.
- Both spouses must meet the use test.
- No exclusion has been used in the previous 24-month period.
Let’s pretend that a person had owned a home from more than two years. This person married and moved into their new spouse’s home two years, six months ago. That person decided to sell the home and would have approximately $200,000 of gain in the sale.
If the property is put on the market, sold and closed prior to the three-years that they moved out, the home would still be eligible for the section 121 exclusion on the sale of a principal residence. If the sales closes after that three-year period, the owner would owe tax on the gain. If the long-term capital gains rate for the owner was 15%, they would owe approximately $30,000 in taxes.
If you or a person you know is in a situation like this, they should certainly seek professional tax advice as well as discussing the marketing and value of the property with their real estate professional. This is something that I have experience with; call me at (815) 842-1400. The timing is very important and critical to a favorable outcome.