Question

Capital gains tax on primary residence

Forum|Forum|4 years ago
October 6, 2021
2 replies
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My wife and I own rental property. This year we will be filing separately. She has moved into one of our rental properties and has made it her primary residence for over a year while I stayed in our original home. She is retired and is 72 years old and makes less than 40,000 in earned income via SS and is planning on selling the property at a capital gain of over 250,000.

Will she have to pay capital gain tax?

M

Mike9241

first there is depreciation recapture to the extent of the gain. then the home sale exclusion on any remaining gain is reduced because of nonqualified use. Period of nonqualified use is any time after 2008 that the taxpayer does not use the home as a principal residence

example.

depreciation taken $20K

buy vacation home 1/1/2012 for 200K

on 1/1/2021 convert to personal residence

sell on 1/1/2022 for $500K

total ownership 10 years (2012-2021)

period of nonqualified use 9 years (2012-2020)

total gain $320K ($500K- ($200K-$20K))

$20K unrecaptured 1250 gain

nonexcludable gain $270K (9/10 * ($320K- $20K)

the remaining $30K would also be taxable because the period of personal use as a principal residence is less than 2 years.

O

Opus 17

Employee

Yes, she will owe tax.

First, she can't claim the exclusion until she has lived there 2 years.

Second, if she does claim the exclusion, the rental period before moving into the house is considered "non-qualified" for the exclusion. This was put in place by Congress specifically to prevent what you are trying to do—landlords making their property exempt from capital gains by moving into the home for a little while.

Suppose the home was a rental for 10 years, and she lives in it for 2 years. Only 2/12 the gain is "qualified", so only 2/12 is eligible for the exclusion, and the other 10/12 of the gain is taxable.

Third, all the depreciation you took or could have taken must be recaptured, that is taxed. Recapture is taxed as ordinary income up to 25%. You will need your tax records for the rental property to know how much depreciation you claimed. Recapture is taxed first, before looking at the long term rate or the exclusion for selling the home you live in.

Fourth, if you own the property together, you each report the sale on your MFS return. You each report half the sales proceeds, half the cost, and half the depreciation. You won't get any exclusion. Your wife will only get an exclusion if she lives there more than 2 years and it will only be a partial exclusion due to the qualified use rule. If you are selling the home due to a marital separation or pending divorce, you may want to transfer full ownership to her first so only she is responsible for the taxes. You should each have your own attorney and tax advisor to stop either one of you from making mistakes.

Finally, based on her income, she will be in the 15% capital gains tax bracket for the portion of the gain that is long-term capital gains. She will be in the 22% bracket for the depreciation recapture.