What is Non qualified Use for Primary Residence Exclusion
Generally you’re treated as having qualified use during any period you, your spouse or your former spouse use the property as a principal residence. All other time is treated as a period of non qualified use, regardless of how the property is being used, or even if it is not being used at all. Gain from the sale or exchange of the main home is not excludable from income if it is allocable to periods of nonqualified use after 2008.
Nonqualified Use after 2008 for the Primary Residence Exclusion
Even if you meet the two-out-of-five year test for the primary residence exclusion, gain attributable to “nonqualified” use after 2008 will not be eligible for the exclusion on a later sale. The primary intent of this rule is to deny an exclusion for some of the gain realized by taxpayers who convert a vacation home or rented residence to their principal residence and live it for a few years before selling.
The law as written, treats any period in 2009 or later for which the home is not used as a principle residence by you as “nonqualified use”.
Other Rules for Nonqualified Use for the Primary Residence Exclusion
- Nonqualified use occurring after your last use of the property as a principal residence doesn’t count. For example, if you accept a job transfer to a new city and you aren’t able to sell your old home until two years after you move out, those two years won’t count as nonqualified use.
- A period of “qualified official extended duty” for someone in the uniformed services, foreign service or intelligence community doesn’t count as nonqualified use.
- A period of temporary absence (up to two years) due to change of employment, health conditions or (to the extent specified by the IRS) other unforeseen circumstances doesn’t count as nonqualified use.
Determining the Excludable Gain
To figure the exclusion on a sale where there is non qualified use after 2008, the gain equal to post May 6, 1997 depreciation is taken into account first. No exclusion is allowed for this depreciation amount; this is a long standing rule that is not changed by the non qualified use calculation.
The portion of the remaining gain that is allocable to non qualified use will not be eligible for the exclusion. The allocation is made by multiplying the gain by the following fraction:
Example: Chad Krause buys a house on January 1, 2010 for $350,000 and uses it as a rental property for two years, claiming $20,000 of depreciation deductions. On January 1, 2012, he converts the property to his principal residence.
On January 1, 2014, he moves out and sells the home for $650,000 on January 1, 2015. Gain on the sale is $320,000 ($650,000 sales price – $330,000 basis ($350,000 – $20,000 depreciation)). The $20,000 of depreciation is recaptured as income; as under prior law. Of the remaining $300,000 gain, 40% is attributable to a nonqualified use; during the five years the home was owned by Chad, it was used as rental property for two years (2/5 = 40%). Thus, $120,000, of the gain (40% x $300,000) does not qualify for the exclusion and is taxable. The $180,000 balance of the gain ($300,000 – $120,000 allocated to nonqualified use) is excluded from income; as it is less than the $250,000 primary residence exclusion limit.