Here's how it works:
- You must have owned your primary residence for at least two years.
- You must have LIVED in your primary residence for two of the last five years.
- The exemption does not apply to rental properties.
- The exemption does not apply to properties previously acquired through a 1031 like kind exchange unless you've owned the property for at least 5 years and have lived in it at least 2 of those 5 years as your primary residence.
That's pretty much it. There are of course lots of rules and regulations to make it a bit more tough than that, but basically if you've met those requirements you qualify for the exemption. Let's see a couple of examples:
Scenario 1: Paul and Mary bought their home in January of 2006 and have lived in it since they closed on it. They decide to list it in Februrary of 2008, it sells in 2 weeks and closes February 29th. Net proceeds from the sale of their home totaled $395,000 after paying all expenses. They do not use ANY of the proceeds from the sale of their home to purchase another one. Do they qualify for the exemption? ANSWER: YES THEY DO! They occupied the home for at least two years as their primary residence, and as a married couple they can claim up to a $500,000 exemption from federal income taxes. The new law does not make any requirements for re-investing the proceeds into their next home. They can be off on a glorious trip around the world if they'd like.
Scenario 2: Sigmund is a captain in the US Army. He purchased his home in March of 2001. In May of that same year, he was deployed to Germany for 3 years. During his deployment, he rented his home to his buddy Phil. When he returned in May of 2004, he moved back in and occupied the home until December of 2005 when he was again deployed for one year to Korea, fortunately Phil was looking for a place to rent and he re-rented it from Sigmund. When he returned home in December of 2006, he moved back in and decided to sell the home in November of 2007. The home sold in one month and closed December 31st, 2007. Net proceeds from the sale of Sigmund's home were $310,000. Does Sigmund qualify for an exemption? Answer: Yes, mostly! Sigmund because he is single qualifies for an exemption of up to $250,000. The additional $60,000 would be subject to capital gains tax EVEN if Sigmund decides to re-invest that money in the purchase of a new home. Because Sigmund occupied the home for at least 2 of the past 5 years, he qualifies for the exemption. Nothing in the language from the IRS stipulates that the occupancy must be consecutive.
If you'd like to discuss other possible scenarios, feel free to give me a call. I'm more than happy to help!
The preceding article should not be construed as tax advice. You should always consult a tax professional when questions specific to your situation arise.