Have you ever had a client downsize and plan to move into an investment property they own? You might want to pass on some valuable information and refer them to a tax accountant! It’s important to know and inform your clients that there is a new IRS tax rule on capital gains when making a previously held investment property your primary residence.
The IRS use to say that if you move into an investment property and make it your primary residence and as long as you live there for 2 years, you can use your exclusion for capital gains, etc.
Well, that has changed!
A new Tax Law went into effect January 1, 2009 – “The Housing Assistance Act of 2008”.
The Housing Assistance Tax Act of 2008 provides four important tax law changes that impact individuals and small businesses. These tax laws are part of the larger Housing and Economic Recovery Act of 2008 (HR 3221, Public Law 110-289) which provides a number of laws relating to housing and mortgages.
The tax portion of this law mostly concerns housing programs targeted to the investment community. There are a number of revisions to the low income housing tax credit, housing and mortgage revenue bonds, and reform of the rules regarding real estate investment trusts. For individual investors, it is important to note that the low-income housing tax credit program has been expanded, and these credits can now offset the alternative minimum tax. Also, tax-exempt interest from housing bonds is now exempt from AMT.
Quick highlights of tax provisions for individuals and small businesses:
- Tax credit of up to $7,500 for first-time homebuyers, to be repaid over 15 years.
- Additional property tax deduction for people who don't itemize.
- Reporting of credit card and merchant payments to the IRS. (How this relates to housing is beyond me!)
- Prorated capital gains exclusion for real estate for periods of non-primary use.
The amount of profit from the sale of a house that can be excluded is now based on the percentage of time when the house was used as a primary residence. Previously, the tax laws allowed a homeowner to exclude up to $250,000 in gains (or $500,000 for joint filers) as long as the homeowner owned and lived in the house for at least two years out of the five years ending on the date of sale. Now, any gains will need to be allocated based on usage. Only gains allocated to time spent living in the property as a primary residence will qualify for the tax exclusion.
As of Jan 1, 2009 – the IRS wants capital gains for period the property was in use as investment property. So in looking at the timeline above:
- The home was purchased in 2005 as an investment property.
- In 2014, you moved into the property as your primary residence because you were getting a divorce.
- You live there for 2 years and then sell the property in 2016, thus meeting your 2 year ‘use period’ requirement.
The IRS now wants their share of the capital gains tax during the period for Jan 1 up until you moved into the property as your primary residence in 2014. The period of Jan 1 through Dec 2014 is 5 years out of the 11 years you owned the property. So 5/11 of the capital gains is due to the IRS. They don’t care about pre-2009, because the old rule was in effect and is grandfathered in. They only care about the time period from Jan 1, 2009 forward. The exclusion for any capital gains on the remaining 6/11 can be applied if available taking into consideration that any depreciation taken earlier on taxes will need to be recaptured.
Have a great rest of the week and I hope you found this informational!