Home Sale Gain Exclusion - Qualification When Transferring Title

[James Lee]

Hi,

My parents recently transferred their paid-off primary residence (SFH) to me via quit claim deed. My original intent was to rehab the property, hold it out as a rental and open a HELOC on it to access the equity. However, upon further inspection it's looking like the time and cost to repair and bring the property up to code outweighs the benefit, as there are more underlying issues than I initially realized.

I'm trying to think through alternative options given the above scenario. I do have an interested buyer lined up as a backup option if I wanted to sell the house to them.

My question is regarding the rules around qualifying for the capital gains exclusion. Does the 2/5 year rule apply here if I were to transfer the deed back to my parents (e.g. can they then sell the house to the interested buyer and qualify under the rule despite having a "break" in ownership period)? Otherwise, my understanding is that if I sell to this buyer while in possession of title, I am on the hook for paying capital gains tax on sales price less basis.

Thanks!