IRS Code 121

What about IRS Code 121?

“Hi Gary, Your newsletter is interesting and informative. We enjoy reading it and learning from it. I have a question that I would like to ask you. I know that by law if you live 2 of the five years in a house when you sell it you would get $500,000 tax break. Please explain if after 2 years that you lived there and then 2 years that it was vacant because the price was going up, could you then rent it for 2 or 3 years after that and then sell it with the same tax exemption? An agent told me, yes. Please explain. Thank you.”

***ANSWER:
Under IRS Code 121, you must own and live in a home for at least 2 of the past 5 years. Then a single owner can exclude up to $250,000 in gain and a couple can exclude up to $500,000.

If I understand you correctly, you’ve lived in a home 2 years, then left it vacant 2 years. You’re asking if you can rent it another 2-3 years and still use the principal residence tax exclusion.

Currently, this is your situation (for simplicity, I’ve used calendar years):

2002 - Principal Residence
2003 - Principal Residence
2004 - Vacant
2005 - Vacant
2006 - ? ? ? ?

So RIGHT NOW you still qualify for the 121 exclusion.

Now here is your proposed situation:

2003 - Principal Residence
2004 - Vacant
2005 - Vacant
2006 - Rented
2007 - Rented

Under your PROPOSED scenario, you would have only lived in it for 1 of the past 5 years and you would NOT qualify.

By the way, I’m assuming the home wasn’t legally your principal residence while vacant. I believe that’s possible, and even common for military personnel stationed away from home.

NOTE: As I’m not a tax or legal specialist, please confirm all this with your tax advisor!

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