Home Gain Exclusion
People are starting to be affected by the changes so I thought a review might be helpful.
The Housing Assistance Tax Act of 2008 changed the rules around capital gain exclusions for homeowners.
The qualification for the exclusion remains untouched.
- You must meet the ownership test (2 of last 5 years)
- You must meet the use test (2 of last 5 years)
- And you can’t have used the exclusion in the last two years.
And the maximum amounts of the exclusion remain untouched: $250K single, $500K married.
What has changed is what amount of the gain gets to make use of this exclusion.
To figure this out you need to understand qualified and non qualified use. Non qualified use is when you and your spouse are not living in the home with the following exceptions (i.e., the following constitute qualified use).
- All periods before 2009 are considered qualified use.
- Period from when you move out to when you sell the house
- Absence up to two years due to job change or qualified illness
- Absence up to 10 years if deployed for the military or US foreign service
You then take the qualified period and divide it by the total period of ownership. This is the fraction of the gain that can make use of the exemption.
Bonnie buys an investment home in 2008 for $300K and rents it for 2 years. In 2010 she moves in to the home. Two years later she moves out and rents it for a year and then sells the home for $500K.
How much of a gain does she have to pay taxes on?
- She meets the use test and ownership test.
- Ownership period was 5 years
- Qualified use period was: 1yr before 2009 + 2yrs living there + 1yr before sale = 4yrs
So 4/5ths of the $200K gain ($160K) can make use of the exclusion and she will need to pay capital gains tax on $40K of gains. (as a side note there would also be depreciation recapture but since that doesn’t qualify for the exemption anyway, I left it out).
Mary and Bob bought an investment condo for $200K in 2009 and rented it for 18 years. They then lived there for two years and then sold the condo for $800K.
- They meet the use and ownership tests
- Ownership was 20 years
- Qualified use period was 2 years
So 2/20ths of $600K gain ($60K) can make use of the exclusion so they will pay capital gain on $540K of gains.
Why did congress make this change? They needed some additional revenue to help pay for some of the stimulus package and they wanted to close the loophole that allowed real estate investors to move into a rental property for two years and wipe out the taxes on their gains.