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Are there new rules for the primary residence tax exclusion?

November 29, 2004


Subject:  1031 trade
Date:  Mon, 01 Nov 2004
From:  Ronald

We did a 1031 exchange in 2000 and rented out our new property at first. The rental did not perform as expected and put us in debt. We decided to sell our home and move into our rental.

In October of 2005, my husband's plant is closing its doors and he will be laid off. We are planning on selling this townhome in the spring of 2005 and relocating. This townhome has been our primary residence for 3 1/2 years, thus far.

Today I heard the IRS changed the law on these trades. Previously we only had to live in our rental for two years as our primary residence and supposedly on 10/22/04 this law changed to having to live in it for 5 years as a primary residence?

Is this information correct? Can the government go back on people like this and change the rules mid-stream? We've purchased land to build a home in a less expensive area where my husband is planning to get another job.

If you know of this new law, could you please direct me to the exact document issued by the federal government?

Answer

Date:  Wed, 24 Nov

Hello Ronald,

This new rule was adopted as part of the American Jobs Creation Act of 2004 (H.R. 4520.) The section number of the Act is 501(b), adding Internal Revenue Code 164(b)(5).

Let me clarify the change and I hope you will feel better. You are not required to use the home as a principal residence for five years to qualify for the exclusion. The rules that you have to have used the home as your principal residence for two of the last five years and that you haven't claimed the exclusion for a previous sale during the last two years continue to apply. However, you have to have held the home more than five years after the acquisition date.

Since you acquired the home during 2000 and will sell it during 2005, you should be able to plan to have held the home for more than five years when it is sold and qualify for the exclusion. Alternatively, the IRS should be issuing guidance allowing a part of the exclusion when you sell the home due to unforeseen circumstances, such as a loss or change of employment.

The tax laws change often, and sometime people are hurt. For example, back in 1986 the passive activity loss rules were enacted to limit deductions from tax shelters. Shortly after this change was enacted, the Savings and Loan industry collapsed, and the FSLIC was tapped out, resulting in a huge federal bailout of the industry.

Good luck!
Mike Gray

We have more answers to frequently asked real estate tax questions! We also offer up-to-date information about new tax real estate tax developments in Michael Gray, CPA's Real Estate Tax Letter.

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Are there new rules for the primary residence tax exclusion?

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