Beginning with the 2007 tax year, the Internal Revenue Service (IRS) has allowed taxpayers to exclude $250,000 of gain from federal taxation on the sale of principal residences ($500,000 for married taxpayers).
To qualify for the exclusion, the residence that was sold must have been owned by the taxpayer and used as the principal residence for at least two of the five years preceding the sale. In addition, during the 2-year period ending on the date of the sale, the taxpayer must have not excluded a gain from the sale of another principal residence.
Current Tax Perks for Property Owners
Currently this exclusion is available to most taxpayers including those who convert their vacation, rental, or other income-producing properties into their primary residence. This loophole in the law has allowed tax-savvy homeowners that own multiple properties to periodically be entitled to large amounts of tax-free gains.
Essentially, a taxpayer could purchase numerous homes with the intention of living in each for two years and exclude gains up to $500,000 for each sale. This continuous relocation strategy has proven to be very profitable especially considering that gains on real estate generally aren’t subject to other taxes such as self-employment taxes (i.e., Social Security taxes, FICA, etc).
So What Changes Are New in 2009?
Effective with sales of homes occurring after December 31, 2008, exclusions of gains from the sale of principal residences may be potentially limited if the property was used for nonqualified purposes. The term “nonqualified purposes” means use of the property other than as a primary residence.
The portion of the gain that is taxable is the amount related to the period the home was used for non-qualified purposes. This taxable portion is calculated by multiplying the gain on the sale of the residence by a ratio. The ratio is comprised of the aggregate periods of non-qualified use (numerator) in relation to the total period of ownership by the taxpayer (denominator). Note that the remainder of the gain is still eligible for the maximum exclusion of up to $500,000.
Are Their Exceptions To What Is Included In The Ratio?
Yes. The ratio does not include the following (in the numerator):
- Nonqualified use before 01/01/2009. However, note that periods of non-qualified use are still included in the denominator.
- Nonqualified use after use as a principal residence within the five year period applicable to claiming the exclusion.
- Nonqualified use (up to ten years) due to service as a member of the uniformed services, foreign services, or intelligence community.
Nonqualified use (up to two years) due to change in employment, health condition, or other unforeseen circumstances as specified by the IRS.
References:
Internal Revenue Tax Code Section 121
The information contained within this article is for general guidance only. As such, it should not be used as a substitute for consulting with professional accounting, tax, legal or other competent advisers.
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