Housing Bill Signed by President Bush
The Housing and Economic Recovery Act of 2008 was signed into law by President Bush and contains provisions that affect more than just housing assistance and economic stimulus programs. The provisions also affect the ability of homeowners to exclude capital gains from gross income on the sale of their primary residences if the residence was ever used for something besides a primary residence.
Click here for a complete analysis of these changes.
Tax Free Exclusion Reduced on Sale of Primary Residence
Homeowners may not be able to exclude all of the $250,000/$500,000 maximum capital gain exclusion from their gross income on the sale of their primary residence pursuant to Section 121 of the Internal Revenue Code ("121 exclusions") if the home was not used as their primary residence for any period of time.
The ability or inability of the homeowner to exclude capital gains all depends on whether their non-qualified use was before or after the use of the property as a primary residence. Non-qualified use before the property was used as a primary residence will not qualify for the 121 exclusion, while non-qualified use after the use as a primary residence will still qualify provided the taxpayer still qualifies under the other requirements within Section 121.
Allocation of Gain
The amount of gain to be prohibited from 121 exclusion treatment is calculated using a fraction. For example, if the property was held for a total of ten (10) years with eight (8) years as a rental property and two (2) years as a primary residence, 8/10 of the gain would not be excluded and 2/10 of the gain would be excluded as a 121 exclusion. Non-qualified use prior to 2009 is ignored.
Use by the homeowner of the residence for something other than a primary residence is referred to as "non-qualifying use" and means that the homeowner will be prevented from excluding gain from taxable income for the period of time the home was used as a vacation home or held for rental, investment or used in a trade or business (i.e. non-qualifying use).
Primary Residences Vacated
There mere fact that the homeowner moved out and left the property vacant or rented it out will not trigger the non-qualified use provisions and the homeower will still be able to use the entire 121 exclusion provided they still meet the other 121 exclusion requirements.
This change to the 121 exclusion rule applies to the sale of primary residences after December 31, 2008, and, under an extremely generous transition rule, is based only on nonqualified use periods that begin on or after January 1, 2009. Non-qualified use prior to January 1, 2009 is ignored.