Mr. Exeter, or any other experts, please please help me with an answer. I've searched & searched the web for examples of changes to 121 Exclusion that would mirror my situation to guide me but no luck.

Here's my situation:

We had lived in a primary residence up thru December 2006 (house was purchased in 1996), that's when we purchased a new 2nd home and moved out in January 2007. Rather than selling the 1st house, we helped out my sister by renting it to her for below FMV rent. Our mortgage on the 1st house was $1,000/month, but we only charged her rent of $800/month. The going rent for similar homes in our neighborhood that were rented out was at least $1,000/month. We rented it to her from January 2007 thru December 2008 (24 months). So for both tax years 2007 and 2008 we had a net rental loss that we could not use on our individual tax returns. My sister and her husband moved out in January of this year (2009). We've put the property on the market in June and its still not sold as of today (so it has been vacant since January 2009).

Come 12/31/2009 we will have reached exactly 60 months on the Section 121 look-back period. My understanding of Section 121 is that if we are fortunate to have sold & closed on the house by 12/31/2009, then we are in the clear -- we can exclude the entire gain since we did live in the house as a primary residence for total of 24 months out of last 60 months.

What I'm unclear about is what happens if we don't sell / close on the house until after 12/31/2009. How do we calculate how much, if any, of the gain would not qualify for exclusion? Does our renting the house to a relative, for less than fair value, for those 24 months count towards anything that would help our situation? Does any of the period from 1996 thru 2006 when we did live in the house also help us?

Let's assume that on 9/1/2010 we sell / close on the house. Resulting gain on the sale is $30,000. What's the impact to us? How much can we exclude, how much is not excluded?

Are there any strategies we can implement now that would help our case? Should I or my spouse "take residence" in the old house? Any other viable actions we should consider?

Any insights or explanations would be greatly appreciated!!! Thanks all! - Henry M.

dcnkmnarn:

Mr. Exeter, or any other experts, please please help me with an answer. I've searched & searched the web for examples of changes to 121 Exclusion that would mirror my situation to guide me but no luck.

Here's my situation:

We had lived in a primary residence up thru December 2006 (house was purchased in 1996), that's when we purchased a new 2nd home and moved out in January 2007. Rather than selling the 1st house, we helped out my sister by renting it to her for below FMV rent. Our mortgage on the 1st house was $1,000/month, but we only charged her rent of $800/month. The going rent for similar homes in our neighborhood that were rented out was at least $1,000/month. We rented it to her from January 2007 thru December 2008 (24 months). So for both tax years 2007 and 2008 we had a net rental loss that we could not use on our individual tax returns. My sister and her husband moved out in January of this year (2009). We've put the property on the market in June and its still not sold as of today (so it has been vacant since January 2009).

Come 12/31/2009 we will have reached exactly 60 months on the Section 121 look-back period. My understanding of Section 121 is that if we are fortunate to have sold & closed on the house by 12/31/2009, then we are in the clear -- we can exclude the entire gain since we did live in the house as a primary residence for total of 24 months out of last 60 months.

Yes, you would qualify for the entire 121 exclusion up to the maximum of $250,000 or $500,000. 

What I'm unclear about is what happens if we don't sell / close on the house until after 12/31/2009. How do we calculate how much, if any, of the gain would not qualify for exclusion? Does our renting the house to a relative, for less than fair value, for those 24 months count towards anything that would help our situation? Does any of the period from 1996 thru 2006 when we did live in the house also help us?

You would no longer qualify for the 121 exclusion because you can no longer say that you have owned and lived in the property as your primary residence for at least 24 months out of the last 60 months.  You could move back into it and live in it for another 24 months so that you once again qualify for the 121 exclusion.  The rental period would not count against you since it was prior to January 1, 2009. 

The property would qualify as investment property since you had rented it out for two years.  You would be able to defer the payment of your capital gain taxes if you structure a 1031 exchange and acquire other replacement investment property.   

Let's assume that on 9/1/2010 we sell / close on the house. Resulting gain on the sale is $30,000. What's the impact to us? How much can we exclude, how much is not excluded?

You can not exclude any of the gain under Section 121.  You could structure the 1031 exchange and defer the payment of your taxes via an acquisition of replacment property.  You might want to consider acquiring rental property that you would hold as rental property for two or more years and then move into it.  You would once again qualify for the 121 exclusion after you have owned the property for five (5) years and lived in it for at least 24 months. 

Are there any strategies we can implement now that would help our case? Should I or my spouse "take residence" in the old house? Any other viable actions we should consider?

You could move back into the property now so that you can still say that you have lived in the property for at least a total of 24 months (does not have to be consecutive) and buy yourself some more time. 

Any insights or explanations would be greatly appreciated!!! Thanks all! - Henry M.

Does this help?

Mr. Exeter:  thank you for taking time to reply!  Your answer did help, not what I was hoping to hear, but helpful.  If you wouldn't mind please allow me this one follow-up posting.

Where you said:  You could move back into the property now so that you can still say that you have lived in the property for at least a total of 24 months (does not have to be consecutive) and buy yourself some more time. 

If I moved back into the property and lived in it but it sells before a total of 24 months, does that help at all?  Say I move back by 11/1/2009, and manage to sell/close on the house on 9/30/2010, how much of a $30,000 gain could I exclude?

What's the minimum steps we'd have to take so that the IRS accept as personal use?  Do both I and my spouse have to move back?  Does mailing address have to change?

Again thanks for any reply you can provide!!!  - Henry M.

dcnkmnarn:

Mr. Exeter:  thank you for taking time to reply!  Your answer did help, not what I was hoping to hear, but helpful.  If you wouldn't mind please allow me this one follow-up posting.

You are most welcome.

Where you said:  You could move back into the property now so that you can still say that you have lived in the property for at least a total of 24 months (does not have to be consecutive) and buy yourself some more time. 

If I moved back into the property and lived in it but it sells before a total of 24 months, does that help at all?  Say I move back by 11/1/2009, and manage to sell/close on the house on 9/30/2010, how much of a $30,000 gain could I exclude?

It depends.  You have to use the 60 month look back from the date your sale closes.  You would have to add the months in which you lived in the property together, both the older dates/months that are still with in the 60 monthy period, and the newer months once you move back in, in order to determine whether you qualify for a total of 24 months out of the last 60 months.  It will help as long as you can say that you did live in the property for a total of 24 months during the last 60 months.  The 24 months do not have to be consecutive; just a total of 24 months. 

What's the minimum steps we'd have to take so that the IRS accept as personal use?  Do both I and my spouse have to move back?  Does mailing address have to change?

You must live there as your primary residence.  You would only qualify for a maximum of $250,000 tax free exclusion if just one of you satisfy the 121 exclusion requirement. 

Again thanks for any reply you can provide!!!  - Henry M.

You are most welcome.