Taxes when convert Primary to Rental to Primary - 2009 Exclusion?

Question

Hi Everyone, Happy Holidays!In this article about "Taxes when converting your rental to primary" - https://www.nolo.com/legal-encyclopedia/taxes-when-you-convert-your-rental-property-your-personal-residence.html, it mentions an Exception that I hadn't heard of before. I was familiar with the "2 out of 5 year" exemption but not this 2009 exception.I hope that some of you can reconfirm that my belief is correct - that this Exception does not apply to my situation because if it did, then that would be a bad surprise.From the article: "However, a special rule enacted in 2009 limits the $250,000/$500,000 exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home. The rule requires you to reduce pro rata the amount of profit you exclude from your income based on the number of years after 2008 you used the home as a rental, vacation home, or other “nonqualifying use.Here is my situation:I have a Coop in Manhattan that I bought in 2006 and initially lived in for many years as my primary residence but then rented out. I plan to move back in for 2 years as Primary Residence in 2023 and 2024 to cover the 2 out of 5 years. Here are the details:2006-2013: My Primary Residence2014-2022: Rented out 2 out of 3 years during this period (my coop bylaw said that every third year had to be vacant) 2023-2024: I plan to move back in and be my primary residence for 2 years to cover 2 out of 5 year rule so I can take the $500k exemption.Questions:a) I do NOT think that I am subject to this 2009 exception rule as the home was initially my home/primary residence before I started to rent it out, and therefore can take the FULL $500k exemption in 2025 when I sell. I hope that you can either confirm this is accurate. b) Also, for any year of vacancy due to my Coop by law where I need to leave it empty every third year would I just treat those as "regular" rental years but with no income but still take depreciation and all the tax deductions (eg. monthly maintenance, property tax)?Thank you very much in advance and Happy Holidays!L

Ashish Acharya · Answer

It’s called the non qualified use. And yes 9/18 years (counting all the years as it was not your PR. Talk to your tax advisor with more detail on this )would be non qualified. Your roughly 50% gain has to be recognized. Remaining gain will be sheltered under sec 121. Also remember there is a depreciation recapture gain taxed up to 25%.

L Huang · Answer

Hi Ashish and Natalie - Thank you both very much for your responses and hope you had a Happy New Year!I hope you don't mind a followup question as I am still getting some conflicting info.You both wrote that I will not qualify for the full $500k in my situation.However, I have seen some articles that I say that since the apartment was originally my Primary Residence for many years (in my case it was my primary residence for 7 years) before I converted it to a rental, that I would still be able to take the full $500k deducsion (as long as I make it my primary residence again for 2 our of 5 years).For example, 1 article on the Journal of Accountacy web site (https://www.journalofaccountancy.com/issues/2008/dec/newtreatmentforsecondhomeproceeds.html) wrote: "The new rules to 121 contain two exceptions. First, homeowners can move out of their primary residence and convert it to nonqualified use property such as rental, investment or vacation property and still be eligible for the full exclusion, as long as the homeowner meets the other requirements of section 121 at the date of disposition."Can you provide additional feedback on this?Thanks again,L Huang

Natalie Kolodij · Answer

Here is how the actual code reads on that:(B)Gain allocated to periods of nonqualified useFor purposes of subparagraph (A), gain shall be allocated to periods of nonqualified use based on the ratio which—(i)the aggregate periods of nonqualified use during the period such property was owned by the taxpayer, bears to(ii)the period such property was owned by the taxpayer.(C)Period of nonqualified useFor purposes of this paragraph—(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.So it's any period of use after 2009 during which it is not your primary- there is an EXCEPTION for the 2/5 year rule- so had it been your primary- then you move out and rented it for 3 years it would be good. But In this circumstance you fall under the non qualified use rules and will not qualify for the full $500k exclusion. I