Non-qualified use tax on primary residence

10 Replies

Hi all,

I'm looking into the tax implication of selling my current primary residence, which I used as a rental during a 4 year stint my employer sent me abroad. I'm interested to learn if there is any exceptions to the non-qualified use period or if the only option is a 1031. Here are some of the details.

Purchased: May 2010 @ 325k

Primary residence: May 2010 - July 2013

Rental: July 2013 - July 2017 (Period my employer sent me abroad)

Primary residence: Aug 2017 - Aug 2019 (targeting to sale Aug 2019 to qualify for the 2 out of last 5 year capital gains exclusion)

Estimate sale price: $675k

Profit: $350k

Must I count the 4 years my employer sent me abroad and I rented the property as non-qualified use? 

If my math is right this would amount to ~44% or ~23k in capital gains tax @ 15%.

For completeness, I'm also aware I must recapture the depreciation @ 25%.

Thanks in advance.

@Eric Richison

Please talk to your CPA before relying on this calculation :

Total ownership period 9.3
Non-qualified use   4
Gain     350k
Non-excludable gain 151k
Remaining gain   199k
     
Remaining gain of $199 can be excluded under 250/ 500k exclusion 

This is a general calculation. It does not factor in selling expenses and your basis is not adjusted for the depreciation. The part of the gain is taxed at ordinary rate max up to 25% as depreciation recapture. 

@Ashish Acharya , thanks for the response. I have a couple follow up questions.

- Can employment be used an exception for the non-qualified use period? Similar to how the capital gain exemption can be pro rated if you're forced to move for employment.

- If the answer above is no, is the non-excludable gain (151k in your calculation) taxed at the capital gains rate or the ordinary income rate?

@Eric Richison

Yes, it can be used but not more than 2 years. 

Non-qualified period can be ignored if the period of temporary absence (not to exceed an aggregate of two years) is due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the IRS. So for you, if the move was due to employment, your non-qualified is down to 2 years.  

The gain is taxed at a capital gain. 

Originally posted by @Ashish Acharya :

@Eric Richison

Yes, it can be used but not more than 2 years. 

Non-qualified period can be ignored if the period of temporary absence (not to exceed an aggregate of two years) is due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the IRS. So for you, if the move was due to employment, your non-qualified is down to 2 years.  

The gain is taxed at a capital gain. 

Not quite ready to agree.  Eric says his employer transferred him overseas for four years.  This period is not a temporary absence and I don't see anything in the tax code that would allow a 2-year "credit" when the total period of absence exceeds two years.  I see the period of NQU as the entire four years Eric was overseas. 

Unless Eric wants to re-occupy his former residence for much longer than two more years, 1031 exchange is probably his best tax deferral opportunity right now, but, it does not put any money in his pocket if cash-in-hand is the ultimate goal.

Eric Richison,

Is there a compelling reason to sell?  If the property generates a positive cash flow, why not keep it as a rental?  If you need cash, explore a cash-out refinance rather than a sale.

Originally posted by @Dave Toelkes :
Originally posted by @Ashish Acharya:

@Eric Richison

Yes, it can be used but not more than 2 years. 

Non-qualified period can be ignored if the period of temporary absence (not to exceed an aggregate of two years) is due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the IRS. So for you, if the move was due to employment, your non-qualified is down to 2 years.  

The gain is taxed at a capital gain. 

Not quite ready to agree.  Eric says his employer transferred him overseas for four years.  This period is not a temporary absence and I don't see anything in the tax code that would allow a 2-year "credit" when the total period of absence exceeds two years.  I see the period of NQU as the entire four years Eric was overseas. 

Unless Eric wants to re-occupy his former residence for much longer than two more years, 1031 exchange is probably his best tax deferral opportunity right now, but, it does not put any money in his pocket if cash-in-hand is the ultimate goal.

Eric Richison,

Is there a compelling reason to sell?  If the property generates a positive cash flow, why not keep it as a rental?  If you need cash, explore a cash-out refinance rather than a sale.

Dave, I think you are right. I think if you exceed the two year aggregate period, the entire period of absence might be non-qualified. 

@Eric Richison , do you follow? 

@Dave Toelkes my employer is not the US government. I was sent on a 2 year assignment to Germany then once that assignment was ending, they offered me another 2 year assignment in China.

The property does cash flow; however, it is circa 1928 so the ongoing potential maintenance is not ideal for us. We will potentially being moving out of our current market within the next 12-18 months and would like to put the proceeds toward a primary residence, and potentially rental(s), in our new location.

@Eric Richison

If your sale is an installment sale, make sure you collect a large enough downpayment to pay the depreciation recapture tax.  The entire amount of unrecaptured depreciation is taxed as a lump sum in the year of sale even though your sale profit will be received in future installments.

As an alternative, you may want to consider a 1031 into a new rental property in the location where you eventually want to establish your principle residence.  After about two years of rental use, convert your 1031 property to your primary residence.  If this new location is to be your long-term home, then you will have no problem meeting the five years of ownershp test before you become eligible for the §121 capital gain exclusion again, although you will still have depreciation recapture and periods of non-qualified use to deal with if you decide to sell at some future date.

Suggest you discuss the advantages and disadvantages of all your available options with your tax advisor so you can make a fully informed decision.