the rule about 2 out of the last 5 years rule? IRS

[Alan Faitel]

My accountant is worried about my home being sold some day, and the rule about 2 out of the last 5 years rule?

I'm looking for some help with the IRS rule 262 Or Publication 523.

I've owned my principal residence for 20 years. I've turned it into an Airbnb and I rented out for the first time in December 2020. We got income for the first time on Airbnb on 1-12-21, but the home was rented dec -2020.

Help.

[Michael Plaks]

@Alan Faitel

Let's say you paid $200k for this house 20 years ago, and it is worth $450 today. You have $250k of appreciation on the house. If you sold it right after you moved out, you would have owed NO taxes on the sale, due to the special exclusion of up to $250k of gains when selling a residence. (For married couples the exclusion is $500k.)

If you start renting it out and sell within 3 years after moving out, this same exclusion still applies. There's a minor quirk related to depreciation during the 3 years which you will have to return upon sale, but it's not a big deal. The big deal is that you still protect $250k of your gains from taxation.

If you sell it one day too late, you will owe taxes on that $250k upon sale. Plus on the additional appreciation during these 3 years. 

Warning: selling this property within 3 years just to avoid the tax may not be a wise decision if it's a great long-term investment otherwise. You may be in a better position keeping it past the 3-yr mark and employing other tax strategies down the road, such as a 1031 exchange. You also might consider another tax strategy before you approach the 3-yr mark. I recommend consulting with an experienced tax accountant specializing in real estate some time in mid-2023 when you will get close to your 3-yr deadline.