Question on Cap Gains taxes/ Section 121 Exclusion

[Steve K.]

Question on section 121 exclusion for cap gains, specifically the timing of needing to live in the property for 2 of the last 5 years. Does anyone know off-hand if that is for the calendar year or exact dates? Assuming exact dates. I have a client looking to sell who moved in to her house on 10/2/22. She's wondering if she needs to wait until October to sell in order to qualify for section 121? Would it be pro-rated a t all if she were to sell a few months before hitting the 2 year mark? Any other strategies to avoid those cap gains on this sale? I know it's a question for her CPA, which is what I told her obviously, but I'm also just curious myself and thought it might be possible to find our answer more quickly from all the brilliant CPA's on here. TIA!  

[Kislay Shah]

The requirement for the Section 121 exclusion of capital gains on the sale of a primary residence is indeed based on exact dates, not just the calendar year. To qualify, the homeowner must have owned and lived in the property as their primary residence for at least 2 out of the 5 years preceding the sale.

In your client's case, since she moved into the house on October 2, 2022, she would need to wait until October 2, 2024, to meet the 2-year ownership and use requirement. If she sells the property before that date, she would not qualify for the full exclusion unless she meets certain exceptions such as unforeseen circumstances like job loss, health issues, or other qualifying reasons outlined in IRS Publication 523.

Regarding prorating the exclusion, unfortunately, there's no provision in the tax code for prorating the exclusion based on partial years of ownership or residence. It's a strict 2-year requirement.

As for strategies to avoid capital gains on the sale, if your client doesn't meet the ownership and use requirements for the Section 121 exclusion, they might explore other options such as:

1. 1031 Exchange: If the property is an investment property rather than a primary residence, your client could consider a 1031 exchange to defer capital gains tax by reinvesting the proceeds into another investment property.
2. Installment Sale: If your client is willing to accept payments over time, they could consider structuring the sale as an installment sale, spreading the recognition of the gain over multiple tax years.
3. Charitable Remainder Trust: If your client is charitably inclined, they could contribute the property to a charitable remainder trust, receive income from the trust for a certain period, and then have the remaining trust assets pass to charity upon their death, potentially reducing or eliminating capital gains tax.

These are just a few options, and your client's specific financial situation and goals would need to be considered in determining the best approach.

[Steve K.]

Quote from @Kislay Shah:

The requirement for the Section 121 exclusion of capital gains on the sale of a primary residence is indeed based on exact dates, not just the calendar year. To qualify, the homeowner must have owned and lived in the property as their primary residence for at least 2 out of the 5 years preceding the sale.

In your client's case, since she moved into the house on October 2, 2022, she would need to wait until October 2, 2024, to meet the 2-year ownership and use requirement. If she sells the property before that date, she would not qualify for the full exclusion unless she meets certain exceptions such as unforeseen circumstances like job loss, health issues, or other qualifying reasons outlined in IRS Publication 523.

Regarding prorating the exclusion, unfortunately, there's no provision in the tax code for prorating the exclusion based on partial years of ownership or residence. It's a strict 2-year requirement.

As for strategies to avoid capital gains on the sale, if your client doesn't meet the ownership and use requirements for the Section 121 exclusion, they might explore other options such as:

1. 1031 Exchange: If the property is an investment property rather than a primary residence, your client could consider a 1031 exchange to defer capital gains tax by reinvesting the proceeds into another investment property.
2. Installment Sale: If your client is willing to accept payments over time, they could consider structuring the sale as an installment sale, spreading the recognition of the gain over multiple tax years.
3. Charitable Remainder Trust: If your client is charitably inclined, they could contribute the property to a charitable remainder trust, receive income from the trust for a certain period, and then have the remaining trust assets pass to charity upon their death, potentially reducing or eliminating capital gains tax.

These are just a few options, and your client's specific financial situation and goals would need to be considered in determining the best approach.

Thank you Kislay! I’ll have her check out publication 523 to see if she meets any of the qualifying reasons. She is moving to start a new business… 

[Wayne Brooks]

@Steve K. As mentioned, it is exact dates, 730 days. However, there Are exceptions that allow a proration….moving for work, etc.  You can google them up.

[Zachary Jensen]

Quote from @Steve K.:

Quote from @Kislay Shah:

The requirement for the Section 121 exclusion of capital gains on the sale of a primary residence is indeed based on exact dates, not just the calendar year. To qualify, the homeowner must have owned and lived in the property as their primary residence for at least 2 out of the 5 years preceding the sale.

In your client's case, since she moved into the house on October 2, 2022, she would need to wait until October 2, 2024, to meet the 2-year ownership and use requirement. If she sells the property before that date, she would not qualify for the full exclusion unless she meets certain exceptions such as unforeseen circumstances like job loss, health issues, or other qualifying reasons outlined in IRS Publication 523.

Regarding prorating the exclusion, unfortunately, there's no provision in the tax code for prorating the exclusion based on partial years of ownership or residence. It's a strict 2-year requirement.

As for strategies to avoid capital gains on the sale, if your client doesn't meet the ownership and use requirements for the Section 121 exclusion, they might explore other options such as:

1. 1031 Exchange: If the property is an investment property rather than a primary residence, your client could consider a 1031 exchange to defer capital gains tax by reinvesting the proceeds into another investment property.
2. Installment Sale: If your client is willing to accept payments over time, they could consider structuring the sale as an installment sale, spreading the recognition of the gain over multiple tax years.
3. Charitable Remainder Trust: If your client is charitably inclined, they could contribute the property to a charitable remainder trust, receive income from the trust for a certain period, and then have the remaining trust assets pass to charity upon their death, potentially reducing or eliminating capital gains tax.

These are just a few options, and your client's specific financial situation and goals would need to be considered in determining the best approach.

Thank you Kislay! I’ll have her check out publication 523 to see if she meets any of the qualifying reasons. She is moving to start a new business… 

 Please note that the 2 years do not need to be consecutive. It's purely a 24-month out of the last 5 years test. Anyway she can come up with a schedule and proof that she was living there at least 24 months? Best of luck solving this! 

[Steve K.]

Quote from @Zachary Jensen:

Quote from @Steve K.:

Quote from @Kislay Shah:

The requirement for the Section 121 exclusion of capital gains on the sale of a primary residence is indeed based on exact dates, not just the calendar year. To qualify, the homeowner must have owned and lived in the property as their primary residence for at least 2 out of the 5 years preceding the sale.

In your client's case, since she moved into the house on October 2, 2022, she would need to wait until October 2, 2024, to meet the 2-year ownership and use requirement. If she sells the property before that date, she would not qualify for the full exclusion unless she meets certain exceptions such as unforeseen circumstances like job loss, health issues, or other qualifying reasons outlined in IRS Publication 523.

Regarding prorating the exclusion, unfortunately, there's no provision in the tax code for prorating the exclusion based on partial years of ownership or residence. It's a strict 2-year requirement.

As for strategies to avoid capital gains on the sale, if your client doesn't meet the ownership and use requirements for the Section 121 exclusion, they might explore other options such as:

1. 1031 Exchange: If the property is an investment property rather than a primary residence, your client could consider a 1031 exchange to defer capital gains tax by reinvesting the proceeds into another investment property.
2. Installment Sale: If your client is willing to accept payments over time, they could consider structuring the sale as an installment sale, spreading the recognition of the gain over multiple tax years.
3. Charitable Remainder Trust: If your client is charitably inclined, they could contribute the property to a charitable remainder trust, receive income from the trust for a certain period, and then have the remaining trust assets pass to charity upon their death, potentially reducing or eliminating capital gains tax.

These are just a few options, and your client's specific financial situation and goals would need to be considered in determining the best approach.

Thank you Kislay! I’ll have her check out publication 523 to see if she meets any of the qualifying reasons. She is moving to start a new business… 

 Please note that the 2 years do not need to be consecutive. It's purely a 24-month out of the last 5 years test. Anyway she can come up with a schedule and proof that she was living there at least 24 months? Best of luck solving this! 

Thanks! Unfortunately she just hasn’t quite reached the 2 year minimum yet so we’re just trying to figure out if she qualifies for a partial exclusion (doesn’t sound like it), or maybe an exception due to one of the circumstances outlined in Publication 523, or she may just need to wait until after October to sell (1031 isn’t an option as it has never been an investment property, installment sale or putting it in a charitable trust would not work either  as she needs the funds immediately for the next purchase). Appreciate the reply! Cap gains are crazy around here, properties have been going way up in value in a short time period. Good problem to have though.