Limited Exclusions on Sale of Primary Residence Previously Used as Second Home or Rental Property – New Rules
Housing and Economic Recovery Act of 2008

By Robert M. Swaim, E.A.
2009

Life is getting tougher for some people who own more than one home.

Part of the 2008 housing-stimulus package could reduce -- though not eliminate -- the appeal of a tax-saving strategy used by taxpayers who own multiple homes.  While the new law won't affect the vast majority of the nation's homeowners, it will likely affect some people planning to sell their primary residence, claim the full home-sale exclusion to pay little or no capital-gains taxes -- and then move to a second or third home they've owned for some time, convert it into their primary residence for the next two years, sell it and once again pay little or no capital-gains tax.

Under new law, most homeowners can sell their primary residence and exclude as much as $250,000 of the gain if they're single, or $500,000 if they're married and filing jointly with their spouse. To qualify for the full exclusion, owners typically must have owned the home and used it as their primary residence for at least two of the five years prior to the sale.

Under the new law, which takes effect starting in 2009, many owners might not be eligible to claim the full exclusion on a vacation or rental home they convert to a primary residence.  Congressional staffers estimate the new restrictions will raise about $1.4 billion in revenue for the U.S. Treasury Department over the coming decade. The move was designed to plug what Congress sees as a major loophole in a law.

Tax experts predict the new law probably will prompt some wealthy people who own several homes to rethink the home-hopper strategy. "I know one individual with four homes who had planned to convert each of his three vacation and resort properties to a principal residence" and sell each at varying intervals to take advantage of the full home-sale exclusion, thus paying little or no capital gains tax.  That client will pay more tax under the new rules.

In the late 1990s, real-estate agents, developers and others discovered special benefits for home-hoppers: These owners could pay little or no capital-gains taxes by carefully timing which home they used as their primary residence and when they sold it.  For example: consider a married couple with several homes who had lived in their main home for two years or more. They typically could sell their primary residence, exclude as much as $500,000 of the gain from tax -- and then move into a vacation home, make it their new primary residence, live in it two years or more, sell it and once again take advantage of the full $500,000 exclusion.

Under the new law, you can't exclude the gain from the sale of the home allocated to periods of "nonqualified use." That typically refers to any period (after the end of 2008) when the property isn't used by you, your spouse or former spouse as a principal residence.  Note that the new law is effective only for sales beginning in 2009.

Example: Suppose a married couple buys a home on Jan. 1, 2009 for $600,000.  They plan to hold it as an investment.  On Jan. 1, 2012 -- three years later -- they begin using it as their principal residence. They live there two years and sell it on Jan. 1, 2014 for $1.1 million, for a profit of $500,000.

Under the old law, they would have been able to exclude the entire $500,000 gain from their taxable income.  But under the new law, they could exclude only two-fifths of the gain, or $200,000, since the other three-fifths would be considered attributable to the three years the home wasn't their principal residence.

Robert Swaim holds a Masters in Accounting and is an Enrolled Agent in Charleston, SC.  He works with real estate investors for tax returns, audit defense and other IRS problems. He can be contacted at 843-722-5264 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it .