Do I qualify for capital gains exclusion?
I have 2 town home units, 9 & 10. I lived in #10 since 2006 and rented #9. I want to sell both and buy a new larger home using capital gains. I will have approximately $200,000 from #10 and $150,000 from #9 in capital gains. The new home will cost approximately $500,000. If I use these gains as down payment for a new home, do I qualify for capital gain exclusion under Taxpayer Relief Act of 1997?
To qualify for the 121 tax exclusion you must pass two tests, the use test and the ownership test. You must live in your primary residence 2 out of the last 5 years to qualify. You can exclude up to $250,000 if you are married and up to $500,000 if you are married. Since you lived in #10 for at least two out of the past five years and that $200,000 is under $250,000, you do qualify for the capital gain exclusion for that home. However, rental #9 is unfortunately fully taxable at capital gain rates. You could do a 1031 exchange on #9 and buy another rental, but it has to be a rental for a rental – it can’t be a rental for a residence. There’s really no way to roll a gain from a rental into a principal residence.
You qualify for capital gains exclusion only on the unit which qualifies as your primary residence. To qualify, the unit has to have been your primary residence for at least 2 of the last five years. That leaves an interesting strategy. Sell unit 10, take the exclusion. Then move into unit 9 for 2 years, sell it, and all of the gain is tax free. Note, if you have been depreciating 9 on your taxes as a rental property, you will also likely have to recapture depreciation, which can be a substantial tax hit. See a tax advisor, it is worth the money.