2/5 Year Rule Primary Residence Converted to Rental

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2/5 Year Rule Primary Residence Converted to Rental

Sharon Li
Member since 2018 · 7 posts · 0 votes

I purchased my house as a primary residence back in July 2017, lived there for just over two years (until Sep 2019), then moved out due to military re-assignment. I then rented the house out for slightly over one year, and am about to sell it. Since I owned and lived in the house for at least two years, does it qualify for capital gains tax exclusion under the 2/5 rule? All the examples I found were converting rentals to primary residences, wasn't sure if the same applied the other way around as long as I met the 2 year ownership/residence requirement. 

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David Pere
Rental Property Investor · Springfield, MO · Member since 2016 · 1k+ posts · 890 votes
5y

@Sharon Li you qualify, and service members are actually eligible to extend this exemption to 15 years, provided you're still in the military!

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    5y
    Originally posted by @Sharon Li:

    I purchased my house as a primary residence back in July 2017, lived there for just over two years (until Sep 2019), then moved out due to military re-assignment. I then rented the house out for slightly over one year, and am about to sell it. Since I owned and lived in the house for at least two years, does it qualify for capital gains tax exclusion under the 2/5 rule? All the examples I found were converting rentals to primary residences, wasn't sure if the same applied the other way around as long as I met the 2 year ownership/residence requirement. 

    Yes you qualify  

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  • David Pere
    Rental Property Investor · Springfield, MO · Member since 2016 · 1k+ posts · 890 votes
    5y

    @Sharon Li you qualify, and service members are actually eligible to extend this exemption to 15 years, provided you're still in the military!

    2Reply
  • Michael McLeskey
    Accountant · Tempe, AZ · Member since 2020 · 9 posts · 8 votes
    5y

    You do qualify (you may have some depreciation recapture at minimum) but FWIW, there is an difference in the IRS' eyes about when you rent your residence in relation to when you lived there as your primary.  To keep it short, I'll just say it is more favorable to live in your home first then rent it (as long as you owned/ lived in the home 2 out of past five years and meet the other requirements) before you ultimately sell it.  If it were the other way around (rent it first, then live in it for 2 years) you would have some non qualified use which would create some gain that couldn't be excluded. 

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  • Eric Chase
    Rental Property Investor · Germany · Member since 2017 · 74 posts · 22 votes
    5y

    Here's one I'm struggling with that's in this vein. I'm an Active Duty military guy who bought a primary residence in San Antonio in 2008. We lived in it until 2012 when we got orders out of state, but kept it as a rental. Fast forward to 2019 – we actually got orders back to San Antonio and bought another house as a primary residence. There were tenants in the rental, they moved out in August 2020, and we sold it in November. Normally this would be simple in that I definitely qualify for the capital gains extension/exemption because the military moved me away. However...

    1. What might it mean that the military moved me back to this same city many years later when a tenant was in the property? Would I still qualify for the ten year extension even though I moved back to San Antonio?
    2. Whatever the answer might be, do the TurboTax algorithms account for this odd circumstance when I file? How do I navigate that aspect? It was used as a rental in 2020, but would I to sell as a personal residence???

    Would love any thoughts! @Stuart Grazier, have you had any experience with such a circumstance?

    Eric

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  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    5y

    @Eric Chase the first thing to do is STOP using turbo tax. Get a real accountant/tax person to do your taxes. Spend the money for someone to advise you directly. It is probably not something that you spend lots of time keeping up with so let the experts handle that aspect of your business. If it costs $500 or $1000 per year to stay out of trouble AND up to date on the new tax laws, its worth it.

    1Reply
  • Eric Chase
    Rental Property Investor · Germany · Member since 2017 · 74 posts · 22 votes
    5y

    @Rick Pozos, I’m with you. I’m on the lookout for a good one. 

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