Corporate Finance Law Blog : Corporate Finance Lawyer & Attorney : Davis Wright Tremaine Law Firm

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Section 3092 of the Housing and Economic Recovery Act of 2008, which became law on July 30, 2008, modifies the exclusion of gain from the sale of principal residence rules with respect to sales of property after December 31, 2008, as follows:

• The exclusion does not apply to so much of the gain from the sale of property as is allocated to periods of nonqualified use.
• Gain must be allocated to periods of nonqualified use based on the ratio of (i) aggregate periods of nonqualified use during the period the property was owned by the taxpayer, to (ii) the period such property was owned by the taxpayer.
• The term “period of nonqualified use” means any period (other than the portion of any period preceding January 1, 2009) during which the property was not used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse.
•  Among other exceptions from the term “period of nonqualified use,” the term does not include any portion of the 5-year period which is AFTER the last date that the property is used by the taxpayer as the principal residence of the taxpayer or the taxpayer’s spouse.

 This means that if you own property as a vacation rental for the next several years, and then move into it as your principal residence for 2 years, you will have to prorate the availability of the Section 121 exclusion.  Even if you convert your rental, for example, to your primary residence and live in it as your primary residence for two years, the entirety of the exclusion won’t be available to you.