Sale of a home-brass tacks

[Openfire]

In reference to the IRS Issues Home Sale Exclusion Rules, The regs state that a home owner must reside in the home two of the previous five years. How does this work out in practicality? For example, if TP's move out for three years, and return to sell the home, but it does not sell prior to the five years expiring (even though it is on the market) are they still eligible for the $250,000/$500,000 exemption? Has anyone dealt with this? Assuming the TPs do not qualify for any of the Safe Harbors.

[mactoolsix]

Nonqualified Use

Gain from the sale or exchange of the main home is not excludable from income if it is allocable to periods of nonqualified use. Nonqualified use means any period after 2008 where neither you nor your spouse (or your former spouse) used the property as a main home, with certain exceptions (see next).
Exceptions. A period of nonqualified use does not include:

Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home;

Since they lived in the home prior to it's non-use as a home, the non-used time is not nonqualified use. As long as they sell within 5 years of the date they last occupied the home, they would qualify for the full exclusion.

See Nonqualified Use Pub 523

http://www.irs.gov/publications/p523/ar02.html#en_US_2013_publink1000240774

[TaxGuyBill]

For example, if TP's move out for three years, and return to sell the home, but it does not sell prior to the five years expiring

When they "return", are they using the home as a principal residence? The five years don't "expire", it is the most recent 5 years before the date of the sale. When the house is sold, they need to used the home as their principal residence for 730 days (maybe 731 if a leap year) out of the last 5 years. If they don't (and they don't qualify for the Reduced Maximum Exclusion rules), they don't qualify for ANY of the exclusion.

If they moved out and later moved back into the home to satisfy the 2 years, non-qualified use rules come into play (see Mactoolsix's answer). Then they would qualify for a partial exclusion.

[Openfire]

I understand. My question is splitting hairs. Does the house being in escrow count? Does closing have to take place prior to the 5 years? What if the sale falls through? Is an In Progress sale considered a sale?

[mactoolsix]

If they moved out and later moved back into the home to satisfy the 2 years, non-qualified use rules come into play (see Mactoolsix's answer). Then they would qualify for a partial exclusion.

I must respectfully disagree.
The exception to nonqualified applies to
"Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home"

Thus if they purchased Jan 2009 and lived in the home for one month.
Then they moved out and lived elsewhere.
In Jan 2014 (within 5 years of last occupancy) they sell the home.

They satisfied the ownership test.

To figure the portion of the gain allocated to the period of nonqualified use, multiply the gain by the following fraction:
Total nonqualified use during the period of ownership after 2008 / Total period of ownership
There is no nonqualified use, thus the amount of gain that must be excluded is multiplied by zero (the above fraction).

If they lived in the home for 2 years (until Jan 2011), then moved out and sold in June 2014, they would still be within the 5 years of last occupancy.

Am I missing something?

As for which to use - contract date or close of escrow? The house isn't sold until the close of escrow. That's the date we use for the purchase and dispositions.

Mike

[mactoolsix]

Why the nonqualified rules?

Consider the reason for the nonqualified rules.

Landlords were moving into previous rentals to satisfy the 2 years and thus getting the Sec 121 exclusion.

The nonqualified rules put an end to this without penalizing owners that moved out for a few years prior to selling.

Excluding the non-use after occupancy, allows an owner to use Sec 121 without being penalized by the landlord-rental rule.

[TaxGuyBill]

I must respectfully disagree.
The exception to nonqualified applies to
"Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home"

I'm not sure what you are disagreeing with.

I was questioning what "return" meant, and if they used the house again as a principal residence. For example, if they used it as a principal residence for 2008-2009, rented it for 2010-2012, and used it as a principal residence from 2013-date of sale, the rental period is non-qualified use, because it was not after the last date used as a main home.


You also made the comment "As long as they sell within 5 years of the date they last occupied the home, they would qualify for the full exclusion." That is incorrect. They still need to satisfy the 2 out of 5 year principal residence test. Non-qualified use has nothing to do with that requirement.

Mike, do you agree?

Bill

[Gary2]

I, too, got stuck on the "return" and "expiring" issue. Until we find out what is meant by those, I don't think we can address the original question.

The non-qualifying use issue is a tangent, very important, but not what was directly asked. It won't become relevant until after determining whether any of the gain can be excluded.

[Openfire]

Clarification: TP's moved to another state and rented home for 2.5 years. TP's are returning to sell the home (lived in 20 years before relocating), prior to the 2 of previous 5 year time limit expiring. They will stay in the home for a few weeks while fixing it up. The question is relating to specifics: If the home sells a few days outside of the time limit, what is the tax consequence? Is it all or nothing regarding the exclusion? How exact is the IRS on this time line? Has anyone ever had a situation where it comes down to days and weeks becoming a major issue?

[appelman]

It's all or nothing, except...

If you meet the qualifications to claim a partial exclusion.

[Gary2]

Clarification: TP's moved to another state and rented home for 2.5 years. TP's are returning to sell the home (lived in 20 years before relocating), prior to the 2 of previous 5 year time limit expiring. They will stay in the home for a few weeks while fixing it up. The question is relating to specifics: If the home sells a few days outside of the time limit, what is the tax consequence? Is it all or nothing regarding the exclusion? How exact is the IRS on this time line? Has anyone ever had a situation where it comes down to days and weeks becoming a major issue?

From the way you describe it here, "few weeks while fixing it up", that doesn't sound like it's their main home during that period. In that case, it doesn't count, and the "return" statement is simply a red herring. See the discussion of "Main home" in Pub. 523. Is there any chance it could become their main home until closing?

I understand why you're describing it as "outside the time limit", but that's also confusing to others because strictly speaking, it's not the proper way to describe it. To me, they can't possibly sell it outside the time limit, because the time limit is defined as the five years ending on the day of the sale. I'd just phrase it as "they close too late to meet the 2 of 5". I don't mean this to quibble, just to explain why some of us tripped over the wording; the answer is the same either way.

The lesson here is to advise clients that if they move out of a home, with only a vague intent to sell, they need to begin the selling process after two years of non-occupancy, to be sure it sells before they exceed three years of non-occupancy.

[Openfire]

I appreciate your clarification of the wording. That makes perfect sense. Thank you!