Russell Stanaland Estate Planning Law Blog on Lawyers.com

In my work as a CPA, San Francisco estate planning attorney and tax lawyer I have found that one of the best tax breaks available is the ability to exclude up to $250,000 gain on the sale of your principal residence or up to $500,000 for a married couple filing jointly.  In California, this can reduce your tax liability by as much as $120,000.  Up until January 1, 2009 you could take advantage of this exclusion if you owned the property and used it as your principal residence for any two years out during the five years immediately before the sale of the property.  This allows you to buy a house, live in it for two years, then move out and treat it as rental property for three years before selling it and still benefit from the exclusion.  It also allowed you to move into rental property that you have owned for many years and escape tax on half a million dollars of gain as long as you lived in the house for two years. 

As of January 1, 2009, the rules have changed significantly.  Section 121(b)(5) of the Internal Revenue Code now requires that you allocate the gain between periods of qualified and nonqualified use.  Periods of qualified use includes time the property was used as a principal residence.  In general, periods of nonqualified use include any time after December 31, 2008, that the property was as anything other than the principal residence of the seller.  Nonqualified use includes use as rental property as well as use as a vacation or second home.  Any gain attributable to periods of nonqualified use is not excluded for tax purposes.   The gain is allocated between the two periods on a strictly mathematical basis.  If the periods of nonqualified use account for thirty percent of the total time of ownership, then thirty percent of the gain cannot be excluded.

Important exceptions exist to the definition of nonqualified use.  The property can be used for any purpose for three years after it is last used as a principal residence without having these periods count as nonqualified use.  This means it is still possible to move out of a residence and rent it for three years and still exclude the gain.  Periods of temporary absence and periods of absence for active military can be excluded from periods of nonqualified use.  It is also important to remember that any use prior to January 1, 2009, is not nonqualified use.  This means you can move into property that has been treated as a vacation home or rental for twenty years prior to 2009, use it as a principal residence to two years, then sell it and exclude up to $500,000 of gain.

Visit LernerVeit.com to find out more about tax law matters or to connect with one of our San Francisco real estate attorneys, business lawyers or estate planning attorneys.

Lerner, Veit & Stanaland, LLP
744 Montgomery St # 5
San Francisco, CA
1-877-532-1899