rent than move back in? capital gain tax?

[mr.wannabemustache]

What if you rent out your home, and depreciate it while you rent it out, then move back in later for a couple years, then sell, do you have to pay the capital gains tax?

For example if you purchased the home for 250k, and it appreciated to 500k, then decided to rent it, depreciate it, then move back in later and sell. Wondering how the taxation would work. Thanks for the help

[Cwadda]

I believe if you live in the house for 2 out of the last 5 years, you can avoid capital gains tax.

[tralfamadorian]

I believe if you live in the house for 2 out of the last 5 years, you can avoid capital gains tax.

The law was changed in 2008 to make the situation not quite that simple for someone who moves back into a property that was previously under unqualified use.

Example:
OP purchases a home for $250k then rents it for three years. OP moves back in and lives there for two years. OP then sells the property for $500k. OP can deduct up to 2/5 of the gains under sec. 121.

Sell price: $500k
Selling costs: $30k
...
Purchase price: $250k
Depreciation taken during 3 years of rent: ~$20k (rough guess)
...
Capital gains: $220k

2/5 of gains- tax free: $88k
3/5 of gains- taxable: $132k
Taxable depreciation recapture: $20k

[robartsd]

The law was changed in 2008 to make the situation not quite that simple for someone who moves back into a property that was previously under unqualified use.

While your math for the example would be correct based on my reading of Publication 523 if you lived in the home for two years then rented it out for the three years just prior to sale it does not seem to be treated the same if you rent out the home for three years then live in it for two years just prior to sale. Only the depreciation recapture would apply.

Excerpt from IRS Pub. 523:

Determine whether the business or rental space still counts as a business space.
A space formerly used for business is considered residence space if ALL of the following are true:

• You weren’t using the space for business or rental at the time you sold the property,
• You didn’t earn any business or rental income from the space in the year you sold your home, and
• You used the space as residence space for 2 years out of the 5 years leading up to the sale.

If all of these are true, your business usage DOESN’T affect your gain/loss calculations. Complete How To Figure Your Gain or Loss Worksheet and then go to How Much Is Taxable, later.
For more information about using any part of your home for business or renting it to someone, see Pub. 587, Business Use of Your Home, and Pub. 527, Residential Rental Property.

[tralfamadorian]

The law was changed in 2008 to make the situation not quite that simple for someone who moves back into a property that was previously under unqualified use.

While your math for the example would be correct based on my reading of Publication 523 if you lived in the home for two years then rented it out for the three years just prior to sale it does not seem to be treated the same if you rent out the home for three years then live in it for two years just prior to sale. Only the depreciation recapture would apply.

It's actually the opposite. If the owner occupied years are front loaded, then the full $250/500k tax free can be taken. If the owner occupied years are back loaded, then the portion of the appreciation able to be taken is proportionally to the time lived there as a primary residence.

The change was made to prevent abuse. It used to be that this situation was permissible (and now longer is with this rule)-
Over a period of time, a real estate investor purchased five house, each of which has appreciated $200k. The investor could live in each house sequentially for a period of two years each, then sell them gaining $200k/2yrs tax free, regardless of how many years it took for that $200k appreciation to accumulate. $1mil tax free in the bank. Pretty sweet, right?

https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/

[robartsd]

It's actually the opposite. If the owner occupied years are front loaded, then the full $250/500k tax free can be taken. If the owner occupied years are back loaded, then the portion of the appreciation able to be taken is proportionally to the time lived there as a primary residence.

The change was made to prevent abuse. It used to be that this situation was permissible (and now longer is with this rule)-
Over a period of time, a real estate investor purchased five house, each of which has appreciated $200k. The investor could live in each house sequentially for a period of two years each, then sell them gaining $200k/2yrs tax free, regardless of how many years it took for that $200k appreciation to accumulate. $1mil tax free in the bank. Pretty sweet, right?

https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/

The article you link to refers to IRC 121(b)(4) for this rule; but does not provide a link. IRC 121(b)(4) contains language about special rules for surviving spouse. IRC 121(b)(5) as quoted by Cornell does contain the provisions you indicate (I assume an ammendment renumbered the provisions of subsection B since the blog post). I guess the language I found in the IRS Pub 523 applies only to partial business use of the home (renting out a room or using space in the home as a buisness office). It certainly can be hard to find the actual rules.