Rental Sale & Cap Gains

[Terry D EA]

Client lived in the home for three years and two years ago and converted it to rental property. They are selling the property, I don't think the 121 exclusion applies here. Need a reference as well if someone could provide one.

[Margaret CPA in OH]

I'm not sure of the timing here the way it is stated.  But you might want to look at IRC Sec. 121.  Short summary per QF "The individual must have owned and used the home as a principal residence for at least two out of the five years prior to the sale (the two years do not have to be consecutive)."  Your phrase 'three years and two years ago and converted it..' are a bit confusing to me for the timing.  And there would be recapture of depreciation taken.

[grandmabee]

You look back 5 years from date of sale and if they used it for any 24 months in that time then you meet the 121 exclusion.

You still have to pay tax on the depreciation taken, and other requirements must be met for the 121.

[Lee B]

Use the worksheet in Pub 523 starting at page 11. Just took a online CPE class last week that covered this topic.

It gets kind of convoluted. Really glad I never had to do one these!

[Abby Normal]

Maybe I'm not doing 100% correctly, but in ATX I mark the asset 'converted to personal use', then use the 8949 worksheet for sale of a principal residence, and just enter the accumulated depreciation on the appropriate line.

Same for home office.

[Terry D EA]

Sorry everyone, I typed the OP in a hurry and was not very clear. So, here goes, this client purchased this home approximately 5 years ago. After living there for three years, they converted the property to rental and it has been rented for the last two years. I understand the two years doesn't have to be consecutive and I also understand that any depreciation taken has to be recaptured when the property is sold. Because it is still rental property and they are looking into selling it, I don't think the 121 exclusion applies. I understand it would if they convert the property from rental to personal use. If the 121 is allowed due to the five year rule, the depreciation would have to be recaptured which would result in a capital gains tax. I am advising my client against this because they maybe selling their primary residence as well and can only take the 121 exclusion once every two years.

[DANRVAN]

Terry,  you need to review section 121(b)(5) which reduces the exclusion by a ratio determined by the amount of time the residence was held for  nonqualified use after January 1, 2009

Note the exception under 121(b)5(C)(ii)(I) for the 5 year period beginning after the last day the property was used a personal residence.

This means that the exclusion is fully allowed in the situation you described.

On 8/7/2020 at 7:32 AM, Terry D said:

I understand it would if they convert the property from rental to personal use. If the 121 is allowed due to the five year rule,

In that situation the exclusion would be reduced by the ratio of  nonqualified use.  For example, tax payer owns house for ten years (purchased after January 1 2009); rents out the first 8 and then uses as residence for 2 years before selling.  The exclusion is reduced by a ratio of 8/10.

But in your case there is not a reduction in the exclusion since the  nonqualified use began after the last day it was used as residence per 121(b)5(C)(ii)(I). 

Edited August 10, 2020 by DANRVAN

[Terry D EA]

Thankyou!!! This is exactly what I needed.