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I have question regarding to capital gain tax to a sale of a townhouse in WA State. I just want to see if any of you can provide some advise. Thanks!

  • home purchase in 2008 for 385k and was primary residence til 2010
  • converted to rental in 2010 and still a rental today. (Worth about 680k now)

If property owner (married couple) move back to the property in June 2018 and sell the home after 2 years in June 2020. Will the property owner qualify for "Tax Free Exclusion (Capital Gain)" under section 121? If not, how can they qualify for the exclusion. Thank you!

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Yes, since it was their primary residence prior to renting, they can qualify for the full exclusion if they move back in for 2 years prior to selling.

This used to be true even if you bought it as a rental and then moved in before selling, but the HOUSING AND ECONOMIC RECOVERY ACT OF 2008 amended Section 121 to disallow exclusion of gains during unqualified periods.

If it was a rental first and they moved back in, then a fractional amount of the gain would qualify for the exception, i.e. owned for 8 years, rented for 6 and lived in for 2, 25% of gain can be excluded.

When they sell, they'll still owe depreciation recapture for the period it was a rental.

Edit: I see a number of sites that claim the nonqualified use section applies if it was a rental at the onset of the 5-year look-back period, Sec 121 states:

Exceptions: The term “period of nonqualified use” does not include—

  • any portion of the 5-year period described in subsection (a) which is after the last date that such property is used as the principal residence of the taxpayer or the taxpayer’s spouse,

I believe that wording supports my answer, but tax-code is often interpreted differently.

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