The days when you could convert your rental property or vacation home to a principal residence and then use the full $250,000/$500,000 home-sale exclusion to avoid taxes are gone.
Here’s how the $250,000/$500,000 exclusion works today. You must divide your period of home ownership into two categories—qualified and non-qualified use:
Qualified use means the time you or your spouse use the home as your principal residence.
Non-qualified use means anytime January 1, 2009, or later in which neither you nor your spouse (or your former spouse) uses the property as a primary residence.
You allocate gain on the sale of your home between the periods of qualified and non-qualified use, and the gain allocated to non-qualified use doesn’t qualify for the $250,000/$500,000 home-sale exclusion.
You have one important exception to the non-qualified use definition: non-qualified use does not include rental use during the five-year period that’s after the last date you or your spouse used the property as your principal residence.
In other words, if you live in your principal residence for two years or more and then rent it out for three years or less, the rental period is not a “period of non-qualified use,” and you qualify for the $250,000/$500,000 home-sale exclusion.
If you have questions on your qualified and non-qualified use, please don’t hesitate to call me on my direct line at 973-339-7773.