121 Exclusion Under New Rules

Converting a rental property to a primary residence and live in the property at least two years out of the five years before the date of sale; you may not exclude gain up to $250,000 (for the $500,000 for married filing a joint return).

Congress added a new rule on non-qualified use principal residence when it passed the “Housing and Economic Recovery Act of 2008.” As a result, a taxpayer cannot exclude the portion of gain which belongs to non-qualified use of primary residence from his/her gross income.

Here is an example to illustrate the current laws on gain exclusion.

• Bought a home on January 1, 2009, for $700,000 and rented the place until December 31, 2018.

• From January 1, 2019, to December 31, 2020, personal residence.

• The depreciation claimed on the property when rented was $100,000.

• Sold it on 06/30/2021.

Computation of Gain:

Cost Basis: 700,000

Less depreciation: (100,000)

Adjusted basis: 600,000

Sale price: 1,700,000

Net gain: 1,100,000

Analysis:

- No Exclusion for depreciation deducted and depreciation recapture of $100,000 tax at the rate of 25%.

- Meets the requirements state in IRC 121 exclusion because he owed and used the home as his principal residence for 2 out of 5 years before the sale.

- He must determine how much gain belongs to the period of non-qualified use and cannot be excluded from his income.

Calculations:

- The first 10 years: non-qualified use: (10/12.5) = 0.8; 0.8*1,100,000 = $880,000 (long term capital gains and cannot exclude from his income)

- 2,5 years – qualified use: (2.5/12.5) = 0.2; 0.2*1,100,000 = 220,000 (excludable from his income)

https://www.law.cornell.edu/uscode/text/26/121