Posted by Dave T on October 31, 2009 at 17:20:09:
In Reply to: Re: New Capital Gains for primary residences 2009 posted by Natalie-VA on October 30, 2009 at 18:45:56:
There are two different rule changes in effect and they could both apply to the same property at the same time.
For example, Sally Investor acquires an investment rental property as the replacement property in a 1031 exchange in January 2008 for an acquisition cost of $100K (she got a great deal on an REO property). She uses the property as a rental for three years, more than enough time to establish the exchange.
In January 2011, Sally sees that the real estate market is improving dramatically and she wants to take advantage of the capital gains exclusion on the sale of a primary residence. Sally moves into the property in January 2011, and occupies the property as her primary residence for the next three years.
In January 2014, Sally runs comps and sees that her property is now worth $400K. Sally puts the property on the market as a FSBO and sells it the next day for $350K. Since she originally acquired the property in a 1031 exchange, the $50K adjusted basis she had in her relinquished property became the initial basis for her replacement property, which she further depreciated to $45K during her period of rental use.
Now when she sells the property, Sally will have $5K of unrecaptured depreciation and $300K of profit due to appreciation (assume selling costs are zero for this illustration).
Sally bought the property in Jan 2008 and sold in Jan 2014, which gives her six full years of ownership. Because Sally has owned the property at least five years, and has occupied the property as her primary residence at least two of the five years prior to sale, Sally is eligible to use the Section 121 capital gains exclusion.
Because two of the years Sally used the property as a rental (and not as a primary residence) occurred after Dec 31, 2008, those two years are non-qualified use. Only 66% of her six years of ownership are qualified use for the capital gains exclusion.
Only 66% of her $300K capital gain, or $200K, can be excluded from capital gains taxes. Because Congress raised the long term capital gains tax rate to 20% in 2013 (just after Obama won reelection), $100K of Sally's sale profit is taxed as a long term capital gain at 20%. In addition, the $5K in allowed depreciation will still be recaptured at 25%.