Question

121 exclusion - convert to primary - IRS behavior?

Forum|Forum|5 years ago
June 3, 2021
3 replies
0 views

Contemplating the sale of a home and wishing to minimize the resulting tax, my question centers on IRS behavior in a specific scenario. The home was used as a rental more than 5 years ago but after 2008. In the terminology of 121 cap gains exclusion, there was no non-qualified use in the 5 year look-back period. Pub. 523 in worksheet 3 instructs the taxpayer to bypass all calculation of a qualified use ratio when no period of non-qualified use exists in the 5 years prior to sale (section b, if you don’t know the verbiage then you aren’t likely the right subject matter expert for this question). So, getting to the question, what, in your experience, has been the IRS’ RESPONSE when homeowners rent out their condo and then convert it to primary residence for 5+ years then, upon the sale of the condo, follow the p523 Wks3 SectionB instructions to take the full exclusion? I want to sell but I cannot un-sell the home if the exclusion is denied in examination so I would like SOME idea of past/recent IRS behavior here in order to make a considered decision.

Not A Product Question

M-MTax

I'm not sure the language you're referring to means what you might think it means. Click the link and scroll down to the bottom of the page. https://www.cpajournal.com/2020/02/05/how-the-loophole-in-irc-section-121-can-benefit-homeowners/

M

msan4444Author

Hi, Thanks for replying but I don't think you are talking about publication 523.

I am referring to this:

Section B. Determine your non-qualified use gain. Complete this section only if there is a period, after the year 2008, when neither you nor your spouse (or your former spouse) used the property as a main home, and that period of non-use occurred during the 5-year period prior to the date of sale and before the time when you or your spouse (or your former spouse) used the property as a main home.* Otherwise, skip to Section C.

The circumstances I described, wherein there was only qualified use during the 5-year period prior to the date of sale, objectively results in skipping to section C. I am inquiring as to outcomes when following this path.

M-MTax

I'm not sure if the instructions are poorly worded or what but you can't rely on ANYTHING in IRS publications because they're not authoritative. Here's a link....https://kb.drakesoftware.com/Site/Browse/14896/1040-Sale-of-Primary-Residence-Used-as-Rental

So, there's the rule and the exception and you're referring to one of the exceptions that states:

A period of non-qualified use doesn’t include

1. Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home.

Seems apparent that you'd have non-qualified use for any period after 2008 if you moved into the home after it was being used as a rental but not if you converted it to rental use after using it as a main home.

M

Mike9241

if you took or should have taken depreciation on property that is now fully qualified for the full 121 exclusion, you still have to recapture the depreciation but not in excess of the gain

Hal_Al

Employee

You may NOT take a full exclusion on the gain.

First, you must recapture (pay tax on) the depreciation "allowed or allowable" (claimed or shoulda been claimed). Second, you must prorate the other gain between rental time (non qualified use) and principal residence time (qualified use)*.

When you enter the home sale in Turbotax (TT), and follow the interview carefully, TT completes the "Home sale work sheet" to handle that complex calculation of the partial home sale exclusion, non qualified (rental) use capital gain and depreciation recapture.

*A period of nonqualified use does not include: Any portion of the 5-year period ending on the date of the sale or exchange AFTER the last date you (or your spouse) use the property as a main home. That does not appear to be your situation.

Rick19744

Employee

I agree with @Hal_Al in that your attempt in reading and quoting a portion of worksheet 3 are not your facts.

The IRS, in general, do a pretty good job at explaining the code and regulations in the publications. However, when the situations get complicated, as is this one, sometimes they are not the model of clarity, but that is their attempt at trying to put into english, Treasury code and regulations and technicalities within the language of each.

The section you are reading is saying that if there was some non qualified use during your last 5 years of ownership beginning AFTER the last date this was considered your principal residence, that time would not be considered non qualified.

By way of example, if you used the home as your principal residence beginning 1/1/ 2014 up until 1/1/2019, moved out and sold it in 2020, 2019 and 2020 would not be considered non qualified use even though you were not using it as your principal residence.

As to your main overriding question on IRS "behavior" if something in a publication may be confusing or misunderstood and you followed what you believe to be accurate based on the publication, you will not prevail if audited, if you go to IRS Appeals, if you go to Tax Court or some other Court. You may not be subject to any penalty, but you will still owe any tax and interest.

*A reminder that posts in a forum such as this do not constitute tax advice.Also keep in mind the date of replies, as tax law changes.