Inman News’ columnist Stephen Fishman recently reported on important tax tips for those “accidental landlords” who ultimately look to sell their home.
In the wake of homeowners-turned-landlords due to the recent downshift in home prices, Mr. Fishman brings up a critical point – the importance of not overlooking the Home Sale Exclusion, one of the biggest and highly valuable home tax breaks available for sellers. For homeowners currently renting their home, who would otherwise sell but are unable – or unwilling – to in this market, timing should be top-of-mind.
“Homeowners who qualify for the home sale exclusion don’t have to pay any income tax on up to $250,000 of the gain from the sale if they’re single, or up to $500,000 if they’re married and file a joint return. Of course, this exclusion is useful only for homeowners who have equity in their homes, not the millions who are “under water” and will receive no profit if they sell their homes.
To qualify for the exclusion, a homeowner must satisfy the ownership and use tests. This means that during the 5-year period ending on the date of the sale, the homeowner must have:
- owned the home for at least 2 years (the ownership test), and
- lived in the home as a primary residence for at least 2 years (the use test).”
Note homeowners that you need not live in the house at the time of the sell, but need to have lived in the home for at least two of the five years prior to the home’s sale date. This scenario can play out in a number of ways:
- Homeowner lives in home first 2 years, renting out the home in the final 3 of 5 years
- Homeowner rents home first 3 years, occupying home as their primary residence in the last 2 of 5 years
“This rule has a very practical application: A homeowner may rent out a home for up to three years prior to the sale and still qualify for the exclusion. However, the exclusion works a bit different for homeowners who have rented out their homes.
They cannot exclude from their income the part of their gain equal to the depreciation they claimed (or could have claimed) while renting the home. Moreover, if the home is rental property at the time of the sale, the sale must be reported to the Internal Revenue Service on Form 4797: Sales of Business Property <http://www.irs.gov/pub/irs-pdf/f4797.pdf> .
Example: Connie purchases a house on Feb. 1, 2007, and lives in it for two full years. She then moves to another state to take a new job. Rather than sell the house in a down market, she elects to rent it out.
If she sells the house by Feb. 1, 2012, she’ll qualify for the $250,000 home sale exclusion because she owned and used the house as her principal home for two years during the five-year period before the sale. If she waits even one more day to sell, she will get no exclusion at all.
Thus, accidental landlords who have equity in their homes need to sell them before the three-year rental period expires, or they’ll lose the home sale exclusion. If they can’t or don’t want to sell, they would have to move back into the home to preserve the exclusion.
Homeowners who don’t qualify for the exclusion will have to pay a 15 percent capital gains tax on their gain from the sale (assuming the home was owned for at least one year).”
Source: Inman News, writer Stephen Fishman “Home selling tax tips for accidental landlords,” April 22nd 2011.