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Financial Information for Senior Military Officers

Movin' Back Into Your Rental? Hold on There Partner!

Movin' Back Into Your Rental?  Hold on There Partner!
I think most home owners are aware of the 2 out of 5 rule when it comes to selling your primary residence.  For those who aren't, the rule basically states that if you lived in your house for 2 of the last 5 years (there is an extension for active duty military) you can exclude $500,000/$250,000 (Married/Single) of Capital Gains from your income.  That means no taxes

When you look at that you might get the idea that you can move back into your rental house for two years and sell it and not pay taxes.  You'd be wrong on two accounts. 

First of all, you have to pay taxes on any "depreciation recapture" (not the topic of today's article).  You also have to pay taxes on gains attributed to "nonqualified use".

So, what is nonqualified use?  Here is what the IRS says:

Generally, a period of nonqualified use is a period after 2008 during which neither the taxpayer nor his spouse (or former spouse) uses the home as a principal residence.

What? You say.  I never heard of this.  I have to admit that the Congress snuck this one through pretty quietly.  I picked up on it a year or so ago during some tax continuing education.  Not all is lost though, there are some exceptions.

 

If you move out of the house and don't move back in during the 5-year look-back period of ownership, the non-residence use is not considered non-qualified.

 

You meet the military exception which includes a period (not to exceed an aggregate of 10 years) during which the taxpayer or spouse is

    1. a member of the military, or
    2. called or ordered to active duty for more than 90 days AND
    3. serves at a duty station at least 50 miles from the principal residence or lives in government quarters under government orders

In other words, if you moved out due to orders and the time away hasn't exceeded 10 years, then the time away isn't considered nonqualified.  It is my opinion once you retire, the exception ends (i.e. nonqualified use begins).

 

If you move temporarily due to a change in employment, health or unforeseen circumstances and the period of temporary absence does not exclude an aggregate of two years

 

The taxable gain is pro-rated based on the time of non-qualified use, not the actual market changes.  So for example, if you owned the house for 10 years and 4 of the years were nonqualified the nonqualified gain would be 40% of the total gain.  It the gain is $100,000 you would owe taxes on $40,000 even if the market tanked during those 4 years of nonqualified use.  The depreciation recapture mentioned above does not really affect this calculations in most cases.

 

As I mentioned, this one was a surprise to me when I learned about it (post 2008).  That is why I generally complete 50 hours a year or more of continuing education...To keep myself on top of these changes and my clients out of trouble.  One thing I've consistently learned throughout the continuing education process is that it is generally easier to plan for tax or other issues than correct problems after the transaction is complete.  That is why I think a plan is so critical.  Plan.  Don't React...

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