Do we qualify for a partial exclusion for capital gains tax?

Question

My wife and I bought a coop in NY at the end of June 2014. She moved to GA for a job November 2015, I joined her at the beginning of April 2016. Staring in March 2016 we began renting our apartment to a friend at a small loss and didn't claim any depreciation on the apartment in our tax returns for FY 2016 and 2017. We put the coop on the market at the beginning of this month as we bought a home in GA last May and our friend's lease of our coop expires at the end of this month.

With all that said, we are trying to determine if we are still eligible for the partial exclusion of capital gains tax due to the job move. Obviously a move from NY to GA is over 50 miles, so we qualify for the "job move" eligibility test. My concern is that the IRS won't deem us eligible since it's a little over 2 years since my wife took the new job and almost 2 years since I moved to GA to join her and no longer claimed the coop in NY as my primary residence. We've spoken to to CPAs and even a family friend who has recently retired from the IRS, and they all think we should be fine since the tax code doesn't have any verbiage on how soon after a job move you have to sell a home.

You'd think with those opinions we'd be comfortable moving forward, but we're both still nervous that come next year when we file our taxes we will end up being audited and owe back taxes for the capital gains on the home. Any and all thoughts/opinions are appreciated. I will tag one particular person on this forum (Brandon Hall) as my search on a related topic seemed to deem you as one of the experts on this subject :)

Thanks in advance for everyone's time and consideration!

-Christian

Christian Mendonca · Answer

@Michael Plaks Thank you for the feedback, Michael. You stating that you would endorse the partial exclusion if we were a client of yours is reassuring. My wife and I are trying to take confidence in the multiple experts who have told us we should be okay, but the one CPA that I spoke with who said he didn't we could claim the partial exclusion continues to concern me a bit as I don't want to assume we will be able to reinvest our proceeds and then come to find out sometime in 2019 that we actually have to pay capital gains. Nevertheless, based upon the math I did using page 7 of this form on the IRS site (https://www.irs.gov/pub/irs-pdf/p523.pdf) and what I think our fees will be associated with closing, our partial exclusion should cover us 100%. So fortunately we lived in the coop long enough to have that covered. As for whether we rented below or at market rate, I will take your advice and discuss with a tax accountant experience in real estate as I want to ensure we handle that piece of the puzzle correctly.Thanks again for your time and help!

Michael Plaks · Answer

@Christian MendoncaThere is some room for debate here, meaning the IRS could potentially challenge this position. That said, the IRS can (and does) challenge even the most non-controversial positions.If you were my client, I would have endorsed your partial exclusion. Not sure if you realize this, but partial exclusion percentage applies not to your gain but to the maximum allowed exclusion. Therefore, even with partial exclusion you might be able to exclude 100% of it.How you treated it for the years of renting to your friend is a separate conversation, with possible complications if you rented it at below market rate. If you did rent it at the market rate, then you will have to reclaim (pay taxes on) depreciation that you were supposed to claim but did not. Discuss with a tax accountant experienced in real estate.

Dave Toelkes · Answer

@Christian MendoncaYou and your wife have different timelines for the 2 year residency requirement. If you are on title to the property then you meet the owndership requiremnt and 87.5% of the occupancy requirement (maybe more depending on the exact dates of purchase and your move out). The unforseen circumstances provisions in the tax code appear to make you eligible for a partial exclusion. Based on your timeline, you can use the §121 capital gains exclusion for up to $218750 (87.5% of $250K) in profit due to appreciation. You will still have to pay taxes on the depreciation you should have taken.Just how I see it.

Senthil Akasham · Answer

@Christian Mendonca, why not do a M453 sale (monetized installment sale)? You can sell any non-primary residential property now, and defer the tax on "all of your capital gain" for 30 years. That's exactly how I sold my own rental property. Not many people know about this type of transaction, but it's been around for many decades, and the super rich use this approach. Let me know if you're interested.