IRS Says: Time May Be Running Out if You Rented Your Home

time may be running outDuring the housing market bust that happened around 2007, some existing homeowners opted to rent out their main residence instead of selling it for less money.

Interestingly, the IRS tax code will allow the temporary rental of a principal residence without the homeowner losing the exclusion of their capital gain with some time limit restrictions. You are given a five-year period which ends on the date the home is sold and you must meet these criteria:

  • Owned the home for at least two years
  • Lived in the home as your main home for at least two years
  • Ownership and use do not have to be continuous nor occur at the same time

If your home has been rented for over three years, it is impossible for you to have lived in it for two of the last five years. So your challenge becomes to sell and close the transaction prior to the crucial five year deadline so you can still take advantage of the gain exclusion.

As an example, take a person who is selling a rented property that has been rented for 2 ½ years although it was previously their main residence. To qualify for the capital gain exclusion, the home should be ready to sell, priced right, sold and closed within six months.

Now, if that person also took depreciation over the period that the home was rented, some part of the gain might not qualify for the exclusion. Depreciation is recaptured at a 25 percent tax rate.

A home that values at $200,000 more than when it was bought could have a $30,000 tax liability so minimizing unnecessary taxes becomes a real concern.

Selling your home for the most money you can get is one thought; but maximizing your proceeds is another. For more information on this topic, refer to IRS publication 523. An example can also be found on the IRS website or consult your tax professional. It is worth seeking help in deciphering these more complicated tax laws.

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