Reduced Exclusion - Sale of primary residence that was converted to rental

[GTS1101]

My client purchased a home as a permanent residence September 11, 2011 in Denver Colorado. This was their primary residence until June 2012 when her job transferred her to California so they began renting out the home in Denver in July 2012. They also did not purchase a home in California. They have been renting the whole time they lived in California. In December 2014 they sold the property in Denver Colorado. My question is since this was their primary residence first can they use the 2 out of 5 rule with a reduced exclusion because of a job related move after 10 months in the home? Or would they have had to sold it immediately after the job transfer to use the 2 out of 5 rule with reduced exclusion due to job transfer after 10 months? I am leaning towards them being allowed to use the 2 out of 5 but I wanted to see if anyone else had a different opinion.

GTS1101

[Kram BergGold]

Yes, But

I would say they qualify for a reduced exclusion. But, they have to pay tax on the allowed or allowable depreciaiton during the rental period.

[kathyc2]

IRS Pub 523 lists a factor as "You sold your home not long after the situation arose".

Some things to consider:

How much of the total gain was from time it was residence and from time it was rental?
It appears they did not try to sell as it was rented out within month of moving.
If the reason they didn't sell is that at time of move they had negative equity you may have a point to argue as to why they didn't sell.

[TaxGuyBill]

My opinion would be that it does not qualify for the exclusion.

Because it was rented for 2.5 years, it does not seem like the "primary reason" for the sale was the job change. Also, the sale and the circumstances giving rise to the sale don't seem to be "proximate in time". However, that is only my opinion. Perhaps there are PLRs that show the IRS thinks otherwise.

https://www.law.cornell.edu/cfr/text/26/1.121-3