JANUARY 17TH, 2018
NOW THAT THE DUST HAS SETTLED
It is always important to note that the new tax code provisions that just
passed the Congress are going to be subject to further regulations and
interpretations. We know that the IRS is feverishly working on those and any
one of the pieces of information contained in this update may have some fine
tuning coming from the IRS as time goes on.
This is just a general overview of some of the many tax law changes and
does not replace you seeking competent tax advice for your individual
situation. While the Congress indicated their intent to simplify matters, they
really made matters more complicated. I think all of you would agree.
INDIVIDUAL TAXATION
MATTERS
Individual Taxation Rates and Individual Deductions
*Beginning in 2018, the Act reduces the maximum individual tax rate from
39.5% to 37%. These rate changes are set to expire January 1, 2026. It is
important to understand that the corporate rates below are permanent, but the
changes at the individual level expire at end of 2025.
*In addition to these rate changes, the standard deduction has been
increased from $13,000 for joint filers, and $6,500 for individuals, to
$24,000, and $12,000, respectively, while the personal exemption for $4,050 has
been repealed.
*The Act also increases the exemption (from $84,500 to $109,400 for joint
filers) and threshold amounts (from $160,900 to $1,000,000 for joint filers) for
individuals subject to the alternative minimum tax. AMT for individuals is
still with us. AMT for corporations is gone.
Miscellaneous Itemized Deductions
*The Act repeals all miscellaneous itemized deductions that were subject to
the 2% floor.
*These include, for example, deductions for tax preparation fees,
unreimbursed employee business expenses, and investment advisory fees.
Mortgage Interest Deduction
*Beginning January 1, 2018, the ceiling on the mortgage interest deduction
has been reduced from $1,000,000 to $750,000 for indebtedness incurred in
acquiring, constructing, or improving a residence. Again, like the individual
rates, this provision is scheduled to expire January 1, 2026.
*For mortgage indebtedness incurred before December 15, 2017, the Act
permits homeowners to maintain the current $1,000,000 ceiling.
*The Act also prohibits the deduction of interest on home equity
indebtedness.
State and Local Taxes
*The Act limits annual itemized deductions for state and local taxes
(including state and local income, property, and sales taxes) to $10,000. Of
course, local taxes in Washington are not relevant.
Medical Expense Deduction
*The Act increases the deductibility of medical expenses by reducing the
threshold for claiming the deduction from 10% of adjusted gross income to 7.5%
for tax years 2017 and 2018.
Alimony and Maintenance
*Alimony and maintenance payments made pursuant to a divorce and separation
agreement will no longer be deductible from income by the payor spouse and
includible in income by the recipient spouse.
*To ensure that taxpayers have time to properly account for these changes,
this new rule will apply only to divorce and separation agreements entered
after December 31, 2018.
CORPORATE AND BUSINESS
INCOME TAX MATTERS
Corporate Tax Rates
*The Act permanently reduces the corporate income tax rate from 35% (the
prior top corporate income tax rate) to a 21% flat rate.
*The Act also repeals the corporate alternative minimum tax (AMT).
Deduction Available to Owners of Pass-through Businesses
*The Act allows owners of certain pass-through businesses, including
partnerships, S corporations, trust and estates, sole proprietorships, real
estate investment trusts (REITs), and publicly traded partnerships (PTPs), to
take a deduction equal to 20% of “qualified business income” (QBI).
*Assuming the full 20% deduction is available to the taxpayer, the
effective marginal tax rate is 29.6% with respect to those taxpayer’s subject
to the highest individual rate.
*QBI includes all domestic business income except investment income (i.e.,
dividends, interest income, short-term capital gains, long-term capital gains,
commodities gains, foreign currency gains, etc.). Compensation paid by S
corporations and guaranteed payments paid by partnerships are not included in
QBI.
*The deduction is subject to many complicated limits and phase-ins; it is
important to note that the deduction is capped at the excess of taxable income
over capital gains.
*In addition, the deduction is limited to the greater of (i) 50% of the
taxpayer’s pro rata share of wages paid by the business, or (ii) 25% of the
taxpayer’s pro rata share of the wages paid by the pass-through plus 2.5% of
the unadjusted basis, immediately after acquisition, of qualified property
(i.e., property subject to depreciation and used in the trade or business).
*This second limitation applies only to partners, shareholders, or sole
proprietors with taxable income more than a threshold ($157,500 for single
filers and $315,000 for joint filers), and will phase in over the next $50,000
of income ($100,000 for joint filers) above these thresholds.
*In general, the deduction does not apply with respect to certain service
businesses (e.g., accounting, law, health, financial services, etc.), except in
the case of taxpayers whose taxable income does not exceed the above
thresholds.
Bonus Depreciation and Section 179 Expensing for
Businesses
*Prior to the Act, taxpayers could take first-year bonus depreciation equal
to 50% of the adjusted basis of new “qualified property.”
*The Act increases bonus depreciation to 100% for both new and used
“qualified property” acquired and placed in service beginning September 27,
2017 and before December 31, 2022.
*The accelerated recovery is reduced by 20% each year for property placed
in service after December 31, 2022.
*In general, “qualified property” is new and used property with a recovery
period of 20 years or less like certain computer software.
*A transition rule also allows businesses to elect to apply a 50% allowance
instead of the 100% allowance for the taxpayer’s first taxable year ending
after September 27, 2017.
*In addition to the foregoing, the amount that a business is allowed to
immediately expense under Code Section 179 (e.g., depreciable tangible personal
property that is purchased for use in the active conduct of a trade or
business, including off-the-shelf computer software and qualified real property
such as qualified leasehold improvement property, qualified restaurant
property, and qualified retail improvement property) has been increased from
$510,000 to $1,000,000 and the types of real estate improvements eligible for
the deduction have also been expanded (e.g., roofs, heating, air-conditioning,
fire protection, etc.).
*The $1,000,000 is reduced (but not below zero) by the amount by which the
cost of qualifying property place in service during the taxable year exceeds
$2,500,000.
Business Interest Deductions Now Limited
*Subject to certain exceptions, the Act limits the business interest
deduction to 30% of earnings before deductions for interest, taxes,
depreciation and amortization (EBITDA) for tax years beginning in 2018.
*For tax years beginning in 2022, the deduction is limited to 30% of
earnings before deductions for interest and taxes (EBIT). This limitation does
not apply to businesses with average annual gross receipts not exceeding
$25,000,000 over the past three taxable years. Unused interest can be carried
forward indefinitely.
*Although real estate businesses are eligible to take first-year bonus depreciation
equal to 100% of “qualified property,” in practice, most real estate assets
(e.g., land and buildings) are not “qualified property.” As a result, unlike
other industries, investors in real estate businesses are permitted to elect
out of the 30% limitation. However, in exchange for the election, the real
estate business will be required to use an alternative depreciation system
(i.e., 40-year depreciable life for nonresidential real property, instead of
39.5 years, and 30-year depreciable life, instead of 27.5 years, for
residential real property), rather than the faster depreciation periods offered
under the Modified Accelerated Cost Recovery System (MACRS).
Net Operating Loss Deductions
*Prior to the Act, a business could carry back net operating losses (NOLs)
to the two preceding years and carry them forward for up to 20 years to offset
100% of taxable income. Under the Act, the deduction for NOLs is now limited to
80% of taxable income. NOLs may not be carried back, but may be carried forward
indefinitely. Importantly, existing NOLs can continue to be carried back 2
years or carried forward up to 20 years and can offset 100% of taxable income.
Like-Kind Tax Deferred Exchanges
*While most types of tangible property (such as airplanes and rolling
stock) were allowed non-recognition treatment under the like-kind exchange
rules, the Act provides that only exchanges of real property would qualify
under Code Section 1031. Non-recognition treatment will still be respected with
respect to property other than real property if it was disposed of before
January 1, 2018.
Entertainment and Other Employer Expenses
*Deductions related to entertainment, amusement or, recreation, and
transportation fringe benefits have been eliminated.
*The deduction for 50% of food and beverage expenses associated with
operating a trade or business would be retained.
*However, the Act limits deductions for the cost of food and beverages
provided to workers to 50% of the cost.
*Beginning with tax years after December 31, 2025, this deduction will be eliminated.
PERSONAL PROPERTY ITEMS IN PURCHASE AND SALE DEALS
Personal property
items are generally not a big factor in a residential real estate purchase and
sale agreements. In real estate transaction, parties can, and commonly do,
include personal property items such as appliances in their transaction. On our
“Legal-Line” we have received many inquiries from Brokers that raise issues
regarding personal property issues.
In our practice,
we also encounter disputes when parties do not specifically include an item
which one party regards as “personal property” and another party regards as a
“fixture” and, therefore part of the “real estate”, and, accordingly, included
as an integral part of the real estate in a real estate purchase and sale
agreement transaction.
In 2008, the
Washington State Court of Appeals Division One (up in Seattle) decided King
v. Rice, 146 Wn. App. 622m 191 P.3d 946 (2008) which discussed the
differences between personal property items which are not “real estate” and
fixtures which are “real estate”.
*****In King,
a Buyer and Seller entered into a real estate purchase and sale agreement.
*****The subject
property was primarily vacant land but included a small house and a modular
living unit located on blocks.
*****The Seller
had placed the modular living unit on the subject property in 1984. The modular
living unit included a bedroom and a kitchen but it was never hooked up to
utilities and was only used to store tools.
*****The
transaction closed and the escrow instructions included a provision stating
that: “The Buyer shall have 20 days after closing to remove the house presently
built on the parcel”.
*****Less than 20
days after closing, the Buyer demolished the modular living unit with a
backhoe.
*****The Seller
sued the Buyer for breach of contract, negligent destruction of personal
property, and malicious mischief.
FINDING OF THE
TRIAL COURT
At the trial
court, the Buyer filed a motion for summary judgment to dismiss the Seller’s
lawsuit arguing that the Buyer’s claims were unsupported by law because the
modular living unit was a fixture and, therefore, part of the “real estate” and
accordingly, after closing the Seller had no legal interest in the modular
living unit. The trial court agreed with the purchaser and dismissed the
Seller’s lawsuit from which the Seller appealed.
FINDING OF THE
COURT OF APPEALS
The Court of
Appeals reversed the trial court’s decision holding there was a genuine issue
of material fact regarding whether the modular living unit was personal
property or a fixture.
In doing so, the
Court of Appeals recited the definition of a “fixture”: (1) the property is annexed
to the realty, (2) its use or purpose is applied to or integrated with the use
of the realty, and (3) the annexing party intended a permanent addition to the
freehold.
In applying this
test to the case at hand, the Court of Appeals reasoned that the modular
storage unit was not “annexed” to the realty because it was not attached to the
ground or utilities and because it had never been listed on county tax records
as part of the real estate.
PRACTICE POINTER: The practice pointer here is that if there is
any ambiguity in a situation, include a specific term addressing the subject
item. Our attorneys can assist in drafting purchase and sale agreement addendum's to prevent costly litigation. Obviously, the laundry list of items on
the multiple listing forms will not create an issue. If you see anything that
could create an ambiguity then address it and come to terms. Storage sheds have
come up quite often in our practice. If in doubt, don’t depend on the law;
depend upon specifically stating what items are being included
TAX BREAKS FOR THOSE WHO ARE
SELLING THEIR PRIMARY RESIDENCE
The topic this
week is totally based upon e-mails to our “Legal-Line” regarding these tax
matters and classes I taught this past week that this topic was a part of the
discussion.
We are not
talking here about any huge new law, but refreshing all my readers’ memories of
a law that was (and is) very favorable to many of your customers, but has been
of little or no consequence during the last seven (7) or so years of our nasty
and long recession. It regards capital gains taxes and primary residences. I
know I have your attention now as this affects all of you. This is a law that
was subject to being changed with a longer holding period. That change did NOT
occur so we still have this wonderful tax exemption available. Read on!!!
You may want to
save this e-mail in your library as the first part DOES go over, in pretty good
detail, the actual rules, but there were a few changes that occurred as late as
“The Housing Assistance Tax Act of 2008” that are probably new to most of my
readers as we were all focused on other matters back in 2008.
Listen up if you
have customers who rent out their properties at some point in time as these new
rules (well, new as of 2008) can affect how much capital gains tax exclusion
they can take if they have a property with what we called “blended use” that is
partly owner occupied and partly non-owner-occupied property.
THIS HOMEOWNER
EXEMPTION IS BETTER THAN SLICED BREAD…….
The exclusion of
up to $500,000.00 of capital gains tax because of the sale of one’s primary
residence can be a great tax benefit to home owners especially since they only
use the exemption a few times during their lives.
We, as real
estate professionals, ALWAYS need to encourage all our customers to seek legal
or tax advice as all areas of taxation are complicated and there can be traps
for the unwary. The goal of this article is to address some of those traps.
LET’S TALK ABOUT
THOSE WHO INVEST IN REAL ESTATE…IS THAT POSSSIBLY YOU?
For those who
invest in real estate, this special tax code creates potentially wonderful tax
planning opportunities. Imagine if you will, your customer (or you) wants to
convert their rental property into a primary residence to take advance of the
primary residence tax exclusion and preclude, not only the capital gains as the
property was held as an investment, but to tack on along the time of the
primary residence holding. When combined with the fact that this exemption can
be used every two (2) years, this could be wonderful for a property investor.
Sorry. You
weren’t the first to look at this opportunity. In fact, this whole scenario
goes back as far as about 15 years ago when this whole exemption came into
being. However, there are still opportunities, but read on. The Congress has
made some changes:
A. They
in the past did preclude depreciation recapture from being eligible for
favorable home owner exemption treatment.
B. They
required a longer holding period (5 years) in a Section 1031 tax deferred
exchange for those parties who converted the use of their investment property.
[I have a dandy tax exchange class being offered throughout the State of
Washington that addresses this issue].
C. More
recently (2008), the Congress has forced gains to be allocated between periods
of “qualifying” use and periods of “non-qualifying” use of the property.
THE NUTS AND
BOLTS OF THE HOMEOWNER EXEMPTION…….(SECTION 121 OF THE TAX CODE)…
I think most of
my readers have a pretty good understanding of the basic rules. It was created
in 1997 by our Congress. No longer do we have to buy a new property [That was
an old law]. No longer do we have a once in a life-time $125K exemption [That
is also old law]. Our current law is called: “The Taxpayer Relief Act of 1997”
and has been modified ever since then. It was NOT modified by the 2018 tax law
changes!!!!
There are lots of
special rules within it and the devil can be in the details. The Publication from
the IRS for layman is not a walk in the park, but PUBLICATION 523 can be a
great help to understand some of the nuances. Just Google “Publication 523” and
you can download and print it out. Again, this short article does NOT replace a
good consultation with one of our tax attorneys here at our law office.
That Act allows a
homeowner (individual) to exclude up to $250K of capital gain on the sale of a
primary residence ($500K for a married couple) so long as the property was
owned and the party used the property as their primary residence for at least
two (2) of the last five (5) years.
PRACTICE POINTER: Keep in mind that BOTH SPOUSES don’t have to own the
house even though this is a community property state. One of the two can own,
but BOTH must live at that property to qualify for the $500K exclusion. Isn’t
that cool?
One does not have
to occupy the property at the time of sale. It is just 2 of the last 5 years.
In other words, the time does not need to be even continuous. We just need 720
days in the last 5 years to qualify. If one moves out after qualifying for the
initial two (2) years, then one has three (3) years to then sell the property
and take advantage of the exclusion rule. Make sure you understand this clearly
as it creates many misunderstandings among professionals and homeowners alike.
PRACTICE POINTER: If your seller does not meet the two (2)
year rule, still have them talk with their tax counsel as they can get a
partial prorated exemption if a change in place of employment, change in
health, or “unforeseen circumstances” all of which require a tax attorney or
tax counsel to review and advise. As the economy improves folks, your sellers
will soon again be experiencing this type of issue.
LIMITATION ON USE
OF THE EXEMPTION……. ONCE EVERY TWO YEARS…….
This exemption
can be used once every two (2) years. Remember, so long as the
requirement is met there is no limit to the number of times an individual can
use that exemption during his or her life. I wonder how many of our customers
out there want to move every two years?
VARIATION ON THE
THEME…WHAT ABOUT RENTAL PROPERTY?
Most of our
customers are not real estate investors. They use this tax savings tool as they
move through their life growing a family and later getting smaller as their
families mature and move on. During the “good times of rapid appreciation”
prior to the recession, many of my clients would “buy up” over time and take
advantage of this exemption repeatedly. Remember that this is an EXEMPTION and
not a deferral. You don’t have to account for that accrued gain afterward like
you do in a tax deferred exchange.
Those same people
would many times also own rental property and would creatively attempt to move
into their rental property taking advantage of the holding period and then
excluding ALL the gain (not only the gain while they lived in the property as
well as the gain while it was used as an investment property). Pretty
great ideas!!!! In addition, because of depreciation the gains in the
investment part would generally accrue faster and thus a pretty good bang for
their tax savings buck if they could pull it off!!!
WHAT IS TOO GOOD
TO BE TRUE IS GENERALLY TOO GOOD TO BE TRUE…. ALONG COMES CONGRESS…….
Over a period of
time, the Congress modified Section 121 (the residence exemption rule) to limit
those strategies. The initial rule eliminated the exemption to apply to any
gains attributable to depreciation taken on the property when it wasn’t being
used as a primary residence. This came into effect on May 6th, 1997
when the original exclusion rule came into effect. So even if you have a
blended property and you meet the two-year residence rule, that portion of the
capital gains that is attributable to
depreciation
taken will be subject to recapture at generally 25% rates. However, one must
read on.
IN 2008, CONGRESS
PASSED FURTHER LIMITATIONS…HOUSING ASSISTANCE TAX ACT OF 2008…….
So, we must read
what happened above and understand that in 2008 Congress further limited the
use of this wonderful exemption (in Section 121(b)(4)) specified that the
exemption is only available when we have the property ACTUALLY used as a
primary residence. The date of that Act is January 1st, 2009.
So, this is
interesting. The Congress deemed all gains are occurring pro-rata during the
whole period of ownership whether owner occupied or not. Periods when the
property is owner occupied are “qualifying”. Periods when used for investment
are “non-qualifying”. Non-qualifying gains are not exempt!!!!!
This is where it
can get complicated and this is where I like to have the client come in and we
sketch out the whole transaction and run out the numbers. This is part of our
$150 initial consultation program. This is an area of tax that we practice
daily.
LET’S TALK ABOUT
THIS WHOLE SUBJECT AND TAX DEFERRED EXCHANGES………BIG PART OF MY PRACTICE……
Before the
Recession literally 98% of my day was involved in matters of Tax Deferred
Exchanges. Kevin Hummel and I have worked together over 15 years now. I got
started in tax exchanges in about 1983. They are a wonderful area of practice. Along
comes the Recession and we aren’t as busy, but short sales to a great degree
took their place.
Now the market is
improving and tax exchanges are back in full swing. This issue of blended
property or converting rental property or investment property into a primary
residence is a big issue for discussion. Folks this is huge.
Notably, there is
an additional “anti-abuse” rule applies to rental property converted to a
primary residence that was previously subject to a 1031 exchange. For instance,
let’s imagine a situation where an individual completes a 1031 exchange of a
small apartment building into a single-family home, rents the single-family
home for a period of time, then moves into the single-family home as a primary
residence, and ultimately sells it (trying to apply the primary residence
capital gains exclusion to all gains cumulatively back to the original
purchase, including gains that occurred during the time it was an apartment
building!). Does this sound like you or one of your customers?
To limit this
activity, the Congress created “The American Jobs Creation Act of 2004 (now IRC
Section 121(d)) affecting specifically tax deferred exchanges. That Act
stipulates the capital gains exclusion on a primary residence that was
previously part of a 1031 exchange is only available if the property has been
held for 5 years since the exchange.
The strategy to
exchange an investment rental for a new investment rental in a location where
you or your customer may wish to retire takes some planning, but will
maximize their tax savings in the end. When one exchanges their current investment
rental property into a new investment rental property, they defer the tax
they would normally have to pay on the gain. This is reflected in the
lower basis assigned to their new replacement property. This, of course, is
basic Section 1031 knowledge.
When they sell
their current principal residence, they may exclude the gain up to
the Section 121 limits. Then, after they convert their replacement
property into their new principal residence, they become eligible once again
for exclusion of up to $250,000/$500,000 of gain after they have owned the
replacement property for five years and used it as a principal residence
for two years. The five-year ownership rule on a principal residence only
applies to properties that have come to your client from an exchange.
Capital gains tax will be due on gains above the Section 121 limits and
any depreciation taken after May 6, 1997.
If your customer
just acquired a property by doing a like-kind exchange, they must hold the new
property as an investment, rental, or business property to qualify for the
exchange itself. We look at the facts and circumstances surrounding the
exchange at the time of the acquisition. No one can tell your client how long
the exchange replacement property must be held in investment status before
they convert it to personal use, but most of our attorneys in our office
recommend not less than one year. IRS issued Revenue Procedure 2008-16 which
defines a safe harbor and includes a two-year holding period of limited
personal use and a rental period if you want to be safe. We are happy to
meet with clients and help you design a transaction that allows you to convert
from investment to primary residence use.
Another issue we
need to revisit in relation to tax deferred exchanges is that effective January
1, 2009, the IRS Section 121 was changed to require parties whether inside or
outside an exchange to allocate gain based upon use. Before the President
signed H.R. 3221, the Housing Assistance Tax Act of 2008, on July 30,
2008, a revenue-raising provision first promoted by Representative Charlie
Rangel (D, N.Y.) was included by the conference committee as Section 3092 of
the bill. This provision was an amendment to Section 121 and has had a
major impact on small landlords and taxpayers who were planning to convert
their rental or second home to a principal residence and then exclude any
gain from their income when they sell the property.
The term “Period
of Non-Qualified Use” referenced in the amendment is very important and
means any period during which the property is not used as the principal
residence of the taxpayer, the taxpayer’s spouse, or a former spouse.
Importantly, the period before January 1, 2009, is excluded. January 1,
2009 is the date upon which this statute became law.
In addition, subsection
(4)(C)(ii) of the amendment provides additional exceptions to the
Period of Non-Qualified Use. These exceptions are (1) any portion of the
five-year period (as defined in Section 121(a)) which is after the last
date that such property is used as the principal residence of the taxpayer
or spouse, (2) any period not exceeding 10 years during which the military
or foreign service taxpayer, or spouse, is serving on qualified official
extended duty as already defined, and (3) any other period of temporary
absence (not to exceed a total of two years) due to change of employment,
health conditions, or such other unforeseen circumstances as may be
specified by the HUD Secretary.
The amendment
states “gain shall be allocated to periods of non-qualified use based on the
ratio which (i) the aggregate periods of non-qualified use during the period
such property was owned by the taxpayer, bears to (ii) the period
such property was owned by the taxpayer.”
How does this
affect your client’s planning?
EXAMPLE FOR
ILLUSTRATION: Suppose
the married taxpayer exchanged into an investment property and rented it
for four years. They moved into it at that time and lived in it for two
additional years. The taxpayer then sold the residence and realized
$300,000 of gain.
Under prior law,
the taxpayer would be eligible for the full exclusion and would pay no
tax. Under the new law, the exclusion will have to be prorated as follows:
four-sixths (4 out of 6 years) of the gain, or $200,000, would be taxable and
thus would be ineligible for the exclusion. Two-sixths (2 out of 6 years) of
the gain, or only $100,000, would be eligible for the exclusion.
Importantly,
non-qualified use prior to January 1, 2009, is not considered in the allocation
for the non-qualified use period, but is taken account for the ownership
period.
EXAMPLE FOR
ILLUSTRATION: Suppose
the taxpayer had exchanged into the property in 2007, and rented it for
three years until 2010, and then converted the property into a primary
residence. If the taxpayer sold the residence in 2013, after three years of
primary residential use, only one year of rental, 2009, would
be considered in the allocation for the non-qualified use. Thus, only
one-sixth (1 out of 6 years) of the gain would be ineligible for the exclusion.
Why? The period before 2009 is not counted as the law was not in effect until
2009.
SPECIAL RULES FOR
PRIMARY RESIDENCE CONVERTED TO RENTAL PROPERTY
In general, the
allocation rules only apply to time periods prior to the conversion into a
principal residence and not to all time periods after the conversion out of
personal residence use. Thus, if your customer converts a primary residence to
a rental and never moves back in, but otherwise meets the two-out-of-five-year
test under Section 121, the taxpayer is eligible for the full exclusion when
the rental is sold. This rule only applies to non-qualified use periods within
the five-year look-back period of Section 121(a) after the last date the
property is used as a principal residence. The rule allows the taxpayer to
ignore any of the non-qualifying use that occurs after the last date the
property was used as a primary residence although the 2 out of the last 5 rules
must be satisfied.
EXAMPLE FOR
ILLUSTRATIVE PURPOSES:
Your client owns a primary residence. Your client bought it and lived in it
since 2008. Your client gets a job offer from California in 2014, but the
economy is still in recession and decides NOT to sell then, but to hold on
until the market improves. She rents it out in 2014 and takes depreciation on
the house. It is now 2015 and the client wants to list the property with you
for sale. Can she take advantage of Section 121 or will she be a landlord or
will she be required to allocate her gain?
Even though there
have been one (1) or potentially two (2) years of non-qualifying use as a
rental it won’t count against her and all amounts will be excludable except for
depreciation recapture. Even though your client does not live in the house as a
primary residence, the client has still used the property as a primary
residence two of the last five years (as she lived there in 2012 and 2013
before renting in 2014).
