sale of former personal residence converted to rental

[lindadod0626]

Client has owned condo since 2005 and rented it out since 2018. She sold it in 2021, and PS is showing capital gains, even though she far exceeds the residence requirement. What am I doing wrong?

[Accountant-Man]

It sounds like what you're doing wrong is not understanding the law.

Did she live in it as her primary residence for 24 months during the last 60 months she owned it?

If she rented it out since 2018(when renting started?), rented 2019, 2020, and part of 2021(when sold?), she might have exceeded 36 months since she last lived in it.

If she sold it in the 37th month after renting started, SHE GETS ZERO EXCLUSION.

[TaxGuyBill]

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@lindadod0626 wrote:

What am I doing wrong?

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You haven't told us what you've done, so it is pretty difficult to help you figure out what you've done wrong.

Have you confirmed they qualify for the exclusion?

Have you 'linked' the Asset Entry Worksheet to the Home Sale Worksheet, and filled out the Home Sale Worksheet?

Have checked what exactly is being taxed?  The gain due to depreciation is not able to be excluded.

[GodFather]

Let's assume the following:

• Sale price:  $750,000
• Purchase Price:  $250,000
• Improvements:    $50,000

The property was rented from 2005 through 2017.  On 1/1/18 the property became the owners primary residence.  It was sold on 12/31/21.  Under this scenario, there would potentially be capital gain, correct?  There would be a need to recapture some of the depreciation taken while the home was rented, no?  Forget about the value of the land for now. 

You don't come across these scenario's often and I would appreciate a kick start to my brain.  Thanks. 

[dkh]

@GodFather   your dates for renting and primary residence are flip flopped from what the OP stated

first it was residence 2005-2017  then it was rented 2018-2021

[GodFather]

That is correct.  That is my assumption for my scenario.  Assuming the property was rented initially and then the owner used it as their primary residence.  I know it is different than the original post.  

[dkh · Accepted solution]

I had this scenario this tax season..... I learned something I did not know.  Big difference in taxable situation if rented then transferred to primary residence prior to selling  than if primary residence then rented then sold.       In my case, although taxpayer lived in home the last 2years prior to selling, he still lost a portion of his $250,000 exclusion because it was rental then primary.  Prorated based on total days owned to totals days rental.

[Accountant-Man]

When did the law change to disqualify the gain that was accrued during the rental period? Before 2018, I believe. 

In other words, the gain accrued from 2005 through 2017, plus depreciation recapture, could never be excluded. The entire gain, not including depreciation, must be allocated by month. In your scenario, 13 years from 2005 through 2017 were non qualified. 

4 years are qualified,  so only 4 out of 17 years of gain could be excluded. 

13 out of 17 years of gain, plus recapture, are non excluded.

[TaxGuyBill]

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@Accountant-Man wrote:

When did the law change to disqualify the gain that was accrued during the rental period? Before 2018, I believe. 

In other words, the gain accrued from 2005 through 2017, plus depreciation recapture, could never be excluded. The entire gain, not including depreciation, must be allocated by month. In your scenario, 13 years from 2005 through 2017 were non qualified. 

4 years are qualified,  so only 4 out of 17 years of gain could be excluded. 

13 out of 17 years of gain, plus recapture, are non excluded.

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The OP said it was rented SINCE 2018 (not before).  Because the rental was at the 'end' (and no Principal Residence after that), there is no Nonqualified Use.

[swarren69]

Your first mistake is posting a question without  providing adequate information to effectively answer it.  Second mistake is it appears you haven’t familiarized yourself with the IRC.  

To receive capital gains exclusion, property must be occupied in 2 of the last 5 years.  2018 - 2021 is 4 years.  Additionally, depreciation recapture would result in a basis reduction which, in turn, probably increased the capital gain.   I’m attaching a helpful link.  

https://www.marcumllp.com/insights/converting-a-personal-residence-to-rental-property

also beware that there are other issues to consider.  For instance, were there multiple rental properties being run as single or multiple businesses?

[swarren69]

Accountant man -

I read with interest your reply about allocating gain on a monthly basis.  What are you talking about?  I’ve never heard of such a thing.  Perhaps you would be so kind as to clarify your comments and educate us with some references to authoritative literature (IRS publications, revenue bulletins, tax and accounting articles, etc).  I’m never too proud to increase my knowledge and would appreciate the time you spend providing the education!

[TaxGuyBill]

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@swarren69 wrote:

I read with interest your reply about allocating gain on a monthly basis.  What are you talking about?  I’ve never heard of such a thing. 

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Look up "Nonqualified Use", from §121(b)(5).

And 2018-2021 averages 3 years of rental use.  It depends on the dates (it could be as little as 2 years, 1 day, or as much as 3 years, 364 days).  So depending on the dates, a person could qualify for the exclusion.

[Accountant-Man]

My response was to dkh, not the OP.

[dkh]

My post probably wasn't clear - I didn't expect any use for rental portion to be excluded from gain.  What I learned was part of the $250,000 exclusion for primary residence can be lost based on total days owned/total days non-qualified use. - thereby increasing taxable gain portion.