Residence - is any gain on the sale taxable?
(Revised December 2012)

Before acting on this topic,
you should seek professional advice

Generally, if you meet the residency requirements, gains up to $250,00 of a residence are tax-free; for married taxpayers filing a joint return, the exclusion generally increases to $500,000. The residency requirement is that you used the residence as your principal residence for at least two of the last five years. The exclusion applies each time a principal residence is sold, as long as the residence was owned and used as the principle residence during at least two of the previous five years. Under certain circumstances (e.g. military service or a job change) the two-year requirement is partially waived.

Residence acquired through 'like-kind' exchange -- If the residence was acquired through a tax free exchange of another property, the residence has to be owned and used as a principal residence for at least five years prior to the sale.  If the property is not used as a principal residence for at least five years, then the $250/500,000 exclusioin does not apply.  If the exclusion rules do apply, part of the gain may be taxable under the rules discussed in the rest of this page.

An example of a like-kind exchange is where you exchanged rental property for other rental property which you then used as your principal residence instead of renting it.

Exclusion applies to portion of home used for business from May 6, 1997 through 12-31-88 - but gain is taxable to extent of depreciation  -- The 250,000/500,000 exclusion rules described above do not apply to any portion of the residence that was subject to depreciation after May 6, 1997. For example, if you claimed (or should have) a home office deduction for one room of your residence, the gain (to the extent of depreciation taken since May 6, 1997) will not be excluded from your income. You cannot avoid the depreciation exception to the exclusion rules by choosing not to depreciate the property on your tax return. The deciding factor is whether or not you were entitled to take the depreciation. Most likely the tax cost of this provision is relatively small, because the annual depreciation deduction was probably a small amount. 

Use of home for business after 2008, no exclusion allowed for the business portion of the residence - that portion of gain fully taxable -- The allowable exclusion is reduced by a numerator equal to the number of days (after 12/31/08 the property was used for non residential purposes divided by the total number of days the property was owned. For purposes of this fraction, the denominator includes any applicable time period before year 2009.

There is one taxpayer friendly exception -- Generally the numerator does not include any vacant period between the time owner moves out of the principal residence and the date the property is sold.  However, you need to keep in mind that if you move out of your principal residence and the sale occurs more than three years later, you lose the entire exclusion.  In this case,  you did not meet the two out of five years requirement of using the property as their principal residence.  In certain cases, a long vacancy (e.g. military service) will not affect the exclusion. This are is very complex; professional advise is recommended.

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