If I move BACK INTO a rental, does the 2/5 year rule apply?

[Jack B.]

I bought the house in 2013 and lived in it for 1.5 years. I moved out and rented the house out for 3.5 years. I just moved back into the house. If I go to sell it in 2-4 years, will any portion of the property sale be allocated to rental use or does the 2/5 year use test apply here since I lived in the house before I turned it into a rental?

[Linda Weygant]

On the day that you sell, you'll do a lookback of 5 years.  If, during that time, you had 2 years of use as your primary residence, then capital gains exclusion applies.  The 2 years need not be continuous.  Having rented it for 3.5 years, it'll be tough to meet that requirement because, for every new day of primary residence, you'll have a day falling off the back end.

[Jeff Brower]

If you 'go to sell in 2-4 years', and live there now, then you will meet the rule.

[Dave Foster]

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

[Linda Weygant]

Originally posted by @Dave Foster:

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

If he's got a full 2 years, there shouldn't be any issue.  Right now, he's only got 1.5 years so if he sold today, there would be partial relief of the gains.  At this point, I think he needs to live in for next 2 years to fully alleviate the gains because of the timing.  Each day he waits, a day is dropping off the back end. 

[Ashish Acharya]

Originally posted by @Dave Foster:

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

 Actually,

If he moves back, he is subject to non qualified use and, capital gain exclusion does not apply to the time preiod that is non qualified.

If the rental period was after moving out of primary residence, there is no non qualified use, 

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.

Simple example

You bought a rental home on January 1, 2012, for $200,000. On January 1, 2015, you converts the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000. Your total ownership period is six years (2012-2017). However, the years 2012-2014 are a period of nonqualified use since the home was not principal residence during those years

Period of nonqualified use	3 years
Total ownership period	6 years
Total gain	($350,000 − $200,000)	$150,000
Nonexcludable gain	(3/6 × $150,000)	75,000

You must report a $75,000 gain for non-qualified use.

The remaining $75,000 ($150,000 − $75,000) of gain can be excluded under 500k exclusion because you meet the two-year ownership and use tests for the home and has not excluded another gain in the previous two years. 

You have to recapture depreciation too.

[Jack B.]

Originally posted by @Ashish Acharya:

Originally posted by @Dave Foster:

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

 Actually,

If he moves back, he is subject to non qualified use and, capital gain exclusion does not apply to the time preiod that is non qualified.

If the rental period was after moving out of primary residence, there is no non qualified use, 

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.

Simple example

You bought a rental home on January 1, 2012, for $200,000. On January 1, 2015, you converts the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000. Your total ownership period is six years (2012-2017). However, the years 2012-2014 are a period of nonqualified use since the home was not principal residence during those years

Period of nonqualified use	3 years
Total ownership period	6 years
Total gain	($350,000 − $200,000)	$150,000
Nonexcludable gain	(3/6 × $150,000)	75,000

You must report a $75,000 gain for non-qualified use.

The remaining $75,000 ($150,000 − $75,000) of gain can be excluded under 500k exclusion because you meet the two-year ownership and use tests for the home and has not excluded another gain in the previous two years. 

You have to recapture depreciation too.

Wait this is confusing. I lived in the house first. Then I rented it out. Then I moved back in. The rental period was AFTER I had first lived in the property.

This isn't a property that was rented out first THEN occupied by me as a primary residence. 

[Dave Toelkes]

@Jack B.,

The problem is that you did not sell during the first 5 year lookback period that included your initial occupancy as a primary residence.  After you had more than 3 year of rental use, your property lost eligibility for the §121 capital gains exclusion and your property became an investment property.  When you move back in and occupy as your primary residence for two years, you reestablish eligibility for the §121 exclusion but the time your property was in service as a rental will be non-qualified use.

[Jack B.]

I'm not sure what to do with this information. Half the people have said the exclusion applies, the other half have said it doesn't because of non qualifying use. I thought NQU could only occur before the property was a primary residence.

For example. You rented the house first, then lived in it. The rental period is NQU and the gain is prorated. 

In my situation I would THINK that since I lived in the property first, then rented it, as long as I move back into it and live there long enough to satisfy the 5 year look back, I'd be good to go exclusion wise. 

[Jim T.]

Originally posted by @Ashish Acharya:

Originally posted by @Dave Foster:

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

 Actually,

If he moves back, he is subject to non qualified use and, capital gain exclusion does not apply to the time preiod that is non qualified.

If the rental period was after moving out of primary residence, there is no non qualified use, 

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.

Simple example

You bought a rental home on January 1, 2012, for $200,000. On January 1, 2015, you converts the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000. Your total ownership period is six years (2012-2017). However, the years 2012-2014 are a period of nonqualified use since the home was not principal residence during those years

Period of nonqualified use	3 years
Total ownership period	6 years
Total gain	($350,000 − $200,000)	$150,000
Nonexcludable gain	(3/6 × $150,000)	75,000

You must report a $75,000 gain for non-qualified use.

The remaining $75,000 ($150,000 − $75,000) of gain can be excluded under 500k exclusion because you meet the two-year ownership and use tests for the home and has not excluded another gain in the previous two years. 

You have to recapture depreciation too.

I understand this process a little differently

I will use your same example; you buy a rental home on January 1, 2012, for $200,000. On January 1, 2015, you convert the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000

The Non-Qualified Usage is 3 years and total ownership is 6 years. I calculate the ratio the same way you did so 3/6 or 50%.

But I thought you reduce the exclusion amount, (e.g. $250,000 for a single) not the cap gain. So now he has a $125,000 exclusion. His profit ($150,000) has a $125,000 exclusion or $25,000 taxable.

Of course, there is depreciation to deal with too. Whatever he deducted in depreciation (or was supposed to deduct) is brought back into play. Let’s say he deducted $10,000 in depreciation for the 3 years it was a rental.

Here is how it plays (Federal only)

$10,000 is taxed at ordinary income rate with a cap of 25%

$25,000 is taxed at long term capital gains rate

Corrections very much appreciated! I am not a pro 

And to the OP, this example is not yours, this is if it was used for non-qualified (one example is for a rental) usage first. In your example, you are entitled to the full exclusion. You do have to recapture what your were entitled to take in depreciation (whether you did or not) and that is taxed at ordinary income with a limit of 25%

[Dave Foster]

@Jim T., The exlusion is not reduced, only the allocations between NQU and QU.  If QU is 50% of the period then he can take 50% of the gain up to the limits of sec 121 tax free.

@Jack B., I get the pain.  Even the brightest of our CPAs sometimes differ and that's why they sign your tax return!  But to your point.  I think the interpretation would be that you did not move back into your primary residence.  You moved into a rental and converted it into your primary residence.  So regardless of what happened prior there is NQU.  

And not to complicate things even further.  But I think you might be able to make a case that the first 1.5 years of QU could count even though it was pre-conversion and then pre second conversion.  In other words you had 1.5 years of QI and then 3 years of NQU and then (for ease of argument) 2.5 years of QU.  You meet the requirements for sec 121.  You have converted a rental to your primary.  So 4/7ths would be tax free up to the limits of sec 121.  3/7ths would be capital gain and depreciation would be recaptured.  Something else to put in the hopper from another CPA friend.

Isn't this fun!!

[Paul Caputo]

@Jack B. The thing here is non-qualified use is only disregarded after qualifying use as long as you still qualify for the section 121 exclusion. That does not appear to be the case here. 

You lived in the property, then rented it for over 3 years so you lost the exclusion. Then after moving back in you'd have to live there for 2 years to regain the partial exclusion due to the non qualifying use on the front end. 

If you first lived in the property, then rented it out for LESS than 3 years and moved back in you'd qualify for the full exclusion. 

The exclusion amount doesn't change: that is if you moved back in and re-qualified you can claim the full exclusion up to the ratio of non-qualifying use. If you have 3.5 years of non-qualifying use and live there for 3.5 years after for qualifying use and sell for a $500K gain your ratio is 50% so you can take the full $250K exclusion. If you sell for $400K gain your ratio at 50% gives $200K exclusion. If you sold for $550K gain you'd max out the exclusion at $250K and have $300K taxable gain. Make sense? That's for the single $250K exclusion but the idea is the same if married. 

In your case you'll have to re-qualify for the exclusion and when you sell it'll be the ratio between NQU and QU up to the limit which you'd probably have to live there awhile to get up to that. Of course depreciation is recaptured to the extent allowed or allowable.

I'm not a CPA, but that's how I read the tax law and it looks black and white to me. Any thoughts @Linda Weygant and @Ashish Acharya?

[Ashish Acharya]

, 

@Jack B. . @Jim T.

Ok.  This is not as complicated as it seems. 

Any period after 2008, that is not used as a primary residence is non-qualified.  There are two exceptions: 

Nonqualified use does not include any period of such use that occurs :

(1) any time during the five-year period ending on the date of sale that occurs after the last day of use as a principal residence, or [ Meaning, of last  5 years, if you  rented a property of last 3 years does not trigger non qualified use, but in the last 5 years, if you first rent for 3 years and then move in for two years as a primary residence, 2/ 5 years is non qualified.]

(2) any time (up to two years) that the taxpayer is temporarily absent due to change in place of employment, health, or unforeseen circumstances. 

Gain is allocated to nonqualified use by multiplying it by a fraction, with the aggregate periods of nonqualified use as the numerator and the total period the taxpayer owned the property as the denominator. Please see the example provided in my first response. 

 @Jack B. , You are just stressing out about this. Your CPA will be treating this the right way. Afterall you paid a good money for him.  

hope that helps

[Paul Allen]

From Section 121 of the code:

(i)In general

The term “period of nonqualified use” means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse.

(ii) The term "period of nonqualified use” does not include—

(I) any portion of the 5-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer’s spouse,

>>>>>>>>>>>>>>>>>>

So....any rental period BEFORE it was a primary residence is NQU.

(Unless another exception applies :P )

[Jack B.]

Originally posted by @Dave Foster:

@Jim T., The exlusion is not reduced, only the allocations between NQU and QU.  If QU is 50% of the period then he can take 50% of the gain up to the limits of sec 121 tax free.

@Jack B., I get the pain.  Even the brightest of our CPAs sometimes differ and that's why they sign your tax return!  But to your point.  I think the interpretation would be that you did not move back into your primary residence.  You moved into a rental and converted it into your primary residence.  So regardless of what happened prior there is NQU.  

And not to complicate things even further.  But I think you might be able to make a case that the first 1.5 years of QU could count even though it was pre-conversion and then pre second conversion.  In other words you had 1.5 years of QI and then 3 years of NQU and then (for ease of argument) 2.5 years of QU.  You meet the requirements for sec 121.  You have converted a rental to your primary.  So 4/7ths would be tax free up to the limits of sec 121.  3/7ths would be capital gain and depreciation would be recaptured.  Something else to put in the hopper from another CPA friend.

Isn't this fun!!

I DID move back into a former primary residence, this wasn't a property bought as a rental, it was a primary residence that I rented out...

[Jack B.]

Originally posted by @Paul Allen:

From Section 121 of the code:

(i)In general

The term “period of nonqualified use” means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse.

(ii) The term "period of nonqualified use” does not include—

(I) any portion of the 5-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer’s spouse,

>>>>>>>>>>>>>>>>>>

So....any rental period BEFORE it was a primary residence is NQU.

(Unless another exception applies :P )

Right, since the house was a primary residence first, it's not NQU that I rented it out when I move back into it...

[Michael Plaks]

@Jack B.

@Ashish Acharya is right. You do have NQU, even though you understandably do not want to believe it.

I will take another shot at explaining the issue.

1. If you move back and live there for 2+ years - you will qualify for the exemption.

2. However, you will only qualify for a pro-rated, not complete, exemption - due to NQU. (See Ashish example if you want to understand the formula.)

3. Anytime you move out and then move back - NQU bites you. In fact, the NQU rule was specifically created to break the loophole of moving back.

4. The only way to avoid NQU is to move out, rent it for less than 3 years and sell without moving back. Too late for that.

5. You can still use a 1031 exchange.

[Paul Allen]

Originally posted by @Jack B.:

Right, since the house was a primary residence first, it's not NQU that I rented it out when I move back into it...

 I don't see anything in the code that mentions what you did with the property FIRST. 

The code says all rental periods are NQU, but makes an exception to NQU for what you did with the property LAST. 

[Wayne Brooks]

Jack B, please listen to these guys who know what they are talking about.....

Once you moved out for more than 3 years it makes no difference that you lived in it first.
The NQU will apply.

[Michael Plaks]

@Wayne Brooks

Actually, NQU would apply regardless of 3 years. Even if you moved out for 1 year only and then moved back - still NQU.

[Jack B.]

Originally posted by @Michael Plaks:

@Wayne Brooks

Actually, NQU would apply regardless of 3 years. Even if you moved out for 1 year only and then moved back - still NQU.

 No it is not, lol. You can rent out for 3 years if you lived in it for 2 years first. All they do is depreciation recapture on sale at that point. 

[Michael Plaks]

Originally posted by @Jack B.:

Originally posted by @Michael Plaks:

@Wayne Brooks

Actually, NQU would apply regardless of 3 years. Even if you moved out for 1 year only and then moved back - still NQU.

 No it is not, lol. You can rent out for 3 years if you lived in it for 2 years first. All they do is depreciation recapture on sale at that point. 

LOL all you want. If you move back - you're subject to NQU rules. The problem is moving back.

[Jack B.]

Originally posted by @Michael Plaks:

Originally posted by @Jack B.:

Originally posted by @Michael Plaks:

@Wayne Brooks

Actually, NQU would apply regardless of 3 years. Even if you moved out for 1 year only and then moved back - still NQU.

 No it is not, lol. You can rent out for 3 years if you lived in it for 2 years first. All they do is depreciation recapture on sale at that point. 

LOL all you want. If you move back - you're subject to NQU rules. The problem is moving back.

Again, you can thump your chest all you want bud, but the fact of the matter is that your original claim that even if you move out and rent it out for only one year that it's somehow NQU is down right incorrect, but keep believing it bud.  It is 1,000% wrong what you claim. It is 1,000% FACT that if you live in the house for 2 years then rent it out for 3 years that the 3 years is not NQU. You somehow in your mind think that even renting it out for a year is NQU. LOL is correct. 

[Michael Plaks]

@Jack B.

You need to read slower, my friend.

Yes, you can rent it for three years and retain the full exclusion - as long as you do not move back in.

Once you move back in - this is when NQU is triggered, even if it was one year later. Do NOT move back in.

[Jack B.]

Originally posted by @Ashish Acharya:

Originally posted by @Dave Foster:

@Linda Weygant Oh CPA Jedi - Will @Jack B.have any issue with "non-qualifying use"?  I know he'll still have to recap depreciation taken but I thought he would also only get the proration for qualified use as a primary.  

 Actually,

If he moves back, he is subject to non qualified use and, capital gain exclusion does not apply to the time preiod that is non qualified.

If the rental period was after moving out of primary residence, there is no non qualified use, 

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.

Simple example

You bought a rental home on January 1, 2012, for $200,000. On January 1, 2015, you converts the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000. Your total ownership period is six years (2012-2017). However, the years 2012-2014 are a period of nonqualified use since the home was not principal residence during those years

Period of nonqualified use	3 years
Total ownership period	6 years
Total gain	($350,000 − $200,000)	$150,000
Nonexcludable gain	(3/6 × $150,000)	75,000

You must report a $75,000 gain for non-qualified use.

The remaining $75,000 ($150,000 − $75,000) of gain can be excluded under 500k exclusion because you meet the two-year ownership and use tests for the home and has not excluded another gain in the previous two years. 

You have to recapture depreciation too.

Can you clarify these comments I highlighted below? I lived in the house first, then rented it out, and would be moving back in. I don't think I have non qualifying use under these circumstances...Or are you saying that even though I lived in it first, then rented it out and THEN moved back in, that period of rental use is now non qualifying use but was not until I moved back in?

If the rental period was after moving out of primary residence, there is no non qualified use,

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.