New Capital Gains for primary residences 2009 - Posted by Kristine-CA

Posted by Tim on October 31, 2009 at 08:55:13:

No offense intended. I had not heard about the new rules for this so I did a Google search. The very first hit I got on my Google search pulled up an explanation in laymens terms that mirrored the very good reply you got from Dave T.

New Capital Gains for primary residences 2009 - Posted by Kristine-CA

Posted by Kristine-CA on October 29, 2009 at 19:56:53:

Can any one please help clarify the following information regarding capital
gains on a primary residences for 2009. I’m reading things that say 2009 will
be different because there will be allocations of the previous 5 years of
primary residence use, similar to before (2 of the previous 5 years).
However, any time after 1/1/2009 that is not primary residence time will be
allocated as owing for capital gains. I’ll use an real-case scenario:

Owner owns and resides in property for 25 years. Value of property $100K.
Moves out of property February 2009, purchases new primary residence. Puts
previous home on the market. Property still hasn’t sold.

When it sells, does the owner owe capital gains based on a percentage of the
5 years that occurs in 2009 where it was not her primary residence.

Assuming property sells December 1, 2009. For taxes filed in 2010:
December 2004 through November of 2009 is the previous 5 year period. Of
the 60 months, 10 of them are in 2009 and not primary residence.

What will capital gains be based on? Thanks!

Re: New Capital Gains for primary residences 2009 - Posted by Dave T

Posted by Dave T on October 30, 2009 at 18:07:46:

Yes, there are recent changes to the tax codes that apply to the income tax treatment when a primary residence is sold.

Before these changes, a homeowner who both owned AND occupied his home as his primary residence for two of the five years prior to sale could exclude up to $250K of profit per taxpayer from capital gains taxes.

One rule change applies to a primary residence that was acquired as the replacement property in a 1031 exchange then converted to a primary residence. For this property, the sale profit can still be excluded from capital gains taxes provided the taxpayer has both OWNED his home FIVE years prior to the sale and occupied the property as his primary residence at least two of the five years prior to the sale.

The more recent change in the tax code went into effect in January 2009. The $250K maximum capital gain exclusion per taxpayer is still in effect if the taxpayer satisfies the two year ownership and occupancy requirements. But, now the profit on the sale must be allocated between periods of qualified and non-qualified use.

Before the rules change, you could vacate your primary residence that you had owned and occupied for the previous four years and convert it to a rental property for two years before the property is sold. All of the sale profit due to appreciation would still be eligible for the capital gains exclusion subject to the $250K limit.

Under the rule change, the period of rental use from Jan 1, 2009 until the property is sold is now a non-qualified period. The portion of the sale profit attributed to the period of non-qualified use is a taxable capital gain, while the portion of the sale profit attributed to periods of qualified use is still excluded from capital gains taxes.

In my example, the homeowner bought the property and occupied it as his primary residence for four years. During the next two years the property was in service as a rental. Finally, after six years of ownership, the property is sold. The homeowner meets the two of five year requirement to exclude his “qualified use” sale profit from capital gain.

Two of the six years of ownership (33%) are non-qualified use, and therefore, 33% of the sale profit due to appreciation is a taxable capital gain. the other 66% of the sale profit due to appreciation is still excluded from capital gains taxes.

If the property is on the market for sale, but not sold before the owners vacate the property, the time it sits empty pending sale is still qualfied use. Should the owners decide to take the property off the market and convert it to a rental, the time the property is used as a rental is a non-qualified period.

In the example you posed in your question, the property sits vacant until it is sold. Provided the homeowner meets the two of five year ownership and occupancy tests when the property is sold, up to $250K of capital gain per taxpayer can be excluded from capital gains taxes.

Re: New Capital Gains for primary residences 2009 - Posted by Tim

Posted by Tim on October 30, 2009 at 12:14:52:

I think your best bet will be to do a google search. Back in the day you could roll over the proceeds from one primary residence into another, with a once in a lifetime exclusion of $125K. In 1997 they changed the law allowing individuals to take $250k($500K/couples) in profit without paying any tax as long as they lived in the home for 2 of the last 5 years. This could be repeated as many times as you wanted as long as you met the 2 out of 5 rule.

I have not fully investigated the new change to the rules. It appears that there is now a tax liability if you have used your primary residence as a rental, vacation home, etc, anytime during your ownership. The rules appear to only apply to this type use after 01/01/09. I’d talk to a tax pro that keeps up with all the changes.

Re: New Capital Gains for primary residences 2009 - Posted by Natalie-VA

Posted by Natalie-VA on October 30, 2009 at 09:04:18:

Kristine,

I think what you are reading has to do with a property that was acquired via a tax deferred exchange.

In the old days, people would defer their taxes on investment properties and then eventually convert the last replacement property into their principal residence. As long as they lived there for 2 years and owned the replacement property for 5 years, they could use the 250/500 principal residence exclusion to avoid paying tax on the gain.

There was a rule change (made in 2008 I think) that tries to close that loophole by making people prorate the gain based on how long the house was a rental versus how long they lived in it.

I believe that is what you’re reading about.

–Natalie

Re: New Capital Gains for primary residences 2009 - Posted by Kristine-CA

Posted by Kristine-CA on November 03, 2009 at 20:15:50:

Dave: thanks for your explanation of both newer tax laws for capital
gains on primary residences. I especially appreciate your examples.
Much easier for me to understand that the IRS website.

Re: New Capital Gains for primary residences 2009 - Posted by Natalie-VA

Posted by Natalie-VA on October 30, 2009 at 18:45:56:

Thanks Dave. I was hoping you would chime in. So, I was incorrect in saying that this rule change only applies to properties acquired via a tax deferred exchange that are converted to principal residences.

Thanks for clearing it up for me.

–Natalie

Re: New Capital Gains for primary residences 2009 - Posted by Kristine-CA

Posted by Kristine-CA on October 30, 2009 at 12:29:21:

No one who knows me would ever ask me to spend more time on
google. I am a google abuser. I come here when google doesn’t
provide the answer in a way I can understand, or when someone with
real life experience can chime in. There are several tax people on this
board who can usually explain some of the details for the lay person,
just like they would explain it to their clients. I find that invaluable.
Google isn’t really interactive.

Re: New Capital Gains for primary residences 2009 - Posted by Kristine-CA

Posted by Kristine-CA on October 30, 2009 at 12:25:55:

Hi Natalie. It appears that the new law applies to all primary
residences, not just those acquired via 1031 exchange. So time after
Jan 2009 that the property is used for rental vs. residence is allocated
to the portion for which one owes capital gains.

I’m trying to figure out the proration, though. I think the formula is
the number of days owed total divided by the number of days used as
non primary residence.

IMO this law really changes the deal for the average homeowner in a
bad way. It means that the person with a home that doesn’t sell easily
and who rents it out for a few months or a year while they figure out
what to do with it will be paying capital gains on that time.

Re: New Capital Gains for primary residences 2009 - Posted by Dave T

Posted by Dave T on October 31, 2009 at 17:20:09:

There are two different rule changes in effect and they could both apply to the same property at the same time.

For example, Sally Investor acquires an investment rental property as the replacement property in a 1031 exchange in January 2008 for an acquisition cost of $100K (she got a great deal on an REO property). She uses the property as a rental for three years, more than enough time to establish the exchange.

In January 2011, Sally sees that the real estate market is improving dramatically and she wants to take advantage of the capital gains exclusion on the sale of a primary residence. Sally moves into the property in January 2011, and occupies the property as her primary residence for the next three years.

In January 2014, Sally runs comps and sees that her property is now worth $400K. Sally puts the property on the market as a FSBO and sells it the next day for $350K. Since she originally acquired the property in a 1031 exchange, the $50K adjusted basis she had in her relinquished property became the initial basis for her replacement property, which she further depreciated to $45K during her period of rental use.

Now when she sells the property, Sally will have $5K of unrecaptured depreciation and $300K of profit due to appreciation (assume selling costs are zero for this illustration).

Sally bought the property in Jan 2008 and sold in Jan 2014, which gives her six full years of ownership. Because Sally has owned the property at least five years, and has occupied the property as her primary residence at least two of the five years prior to sale, Sally is eligible to use the Section 121 capital gains exclusion.

Because two of the years Sally used the property as a rental (and not as a primary residence) occurred after Dec 31, 2008, those two years are non-qualified use. Only 66% of her six years of ownership are qualified use for the capital gains exclusion.

Only 66% of her $300K capital gain, or $200K, can be excluded from capital gains taxes. Because Congress raised the long term capital gains tax rate to 20% in 2013 (just after Obama won reelection), $100K of Sally’s sale profit is taxed as a long term capital gain at 20%. In addition, the $5K in allowed depreciation will still be recaptured at 25%.