I purchased a home that was my primary residence in June of 2010. I was laid off in January of 2011 and turned the home into a rental property in June of 2011. I moved to another city 300 miles away from my home for a job. I am now looking to sell my home, but I am really confused about the capital gain taxes that I would incur. Is there any way to avoid having to pay capital gain taxes on the home since I was laid off and moved because of my job?

ANSWER

The BIDaWIZ Team's Answer:

Based on the information you've provided, you should be able to utilize Internal Revenue Code Section 121 to claim a portion of the capital gains exclusion. This means that if you sell your principal home at a capital gain, you can exclude $250,000 of the profit from your taxable income and $500,000 if you're married. However, to do so you need to meet the IRS defined ownership and use tests. Specifically, you must have owned the house for two years and must have lived in the house as your principal residence for two out of the last five years, ending on the date of the sale. While, you don't meet either test, you can claim that the job loss was an unforeseen circumstance under IRS publication 523. This means that your maximum exclusion will be prorated. The last factor to consider is that the residence was converted to a rental property. Please note that any depreciation taken while the property was a rental will not qualify for the capital gains exclusion, and will instead be subject to depreciation recapture. In addition, the amount of the capital gains exclusion is generally allocated on a pro-rata basis in accordance with how long the property was considered qualified versus non-qualified. Rental property is considered non-qualified use. So, if you own a property for 1 year and it's a rental for 2 out of the 3 years, you may be eligible to exclude 1/3 of the capital gains exclusion on top of the prorated amount of 1/2 for not holding the property for two years. Let's suppose you have a capital gains of $250,000, you would subtract depreciation from the gain, then divide by 1/2 for the prorated unforeseen event, then divided by 1/3 for the qualified/non-qualified rental use. This translates to around $42,000 of a maximum capital gain exclusion excluding the depreciation recapture which you haven't provided. The last item to note is the potential for state capital gains taxes. However, some states confirm to federal tax exemptions such as California.