PMC Mortgage Lender's Blog

In the last couple of years an increasing number of anxious home sellers are opting to rent their homes rather than sell them at a deep loss because of falling home prices.

Attorney and real estate writer, Stephen Fishman warns that “such accidental landlords should understand that if they rent out their homes too long before they sell them, they could lose the biggest tax break available for most people: the home sale exclusion.”

The tax implications of the home sale exclusion means home sellers don’t have to pay any income tax on up to $250,000 (single filer) of the gain from their home sale, or up to $500,000 (married joint filers).

In order to qualify for the exclusion home owners must meet the IRS ownership and use tests for the prior 5-year period ending on the date of their home sale:

Ownership Test: owned the home for at least 2 years;

Use Test: lived in the home as a primary residence for at least 2 years. (Link: IRS)

Example: Single mom, Connie, purchased a house on Feb. 1, 2007 and lived in it for two full years. She then moved to another state to take a new job, but opted to rent her home rather than sell it.

She then decides to sell her home five (5) years after her purchase date on Feb. 1, 2012. Would she qualify for the home sale exclusion? Yes, because she owned and used the house as her principal home for two years during the five-year period before the sale.

If Connie waits just one more day to sell, she would then be subject to a 15 percent capital gains tax on any gain from the sale (assuming there was any gain on the sale.)

The home owner need not be living in the house at the time it is sold. The two years of ownership and use may occur anytime during the five years before the date of the sale.

For home owners who have rented out their homes and qualify for the exclusion, they cannot exclude from their income the part of their gain equal to the depreciation they claimed (or could have claimed) while renting the home. Check with your tax professional for details.

Also, if the home is being used as rental property at the time of the sale the transaction must be reported to the Internal Revenue Service on Form 4797: Sales of Business Property.

Accidental landlords who have equity in their homes need to sell them before the three-year rental period expires, or they’ll lose the home sale exclusion.

If they can’t or don’t want to sell, they would have to move back into the home to preserve the exclusion.