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Selling a Converted Principal Residence

Excluding the gain isn’t so easy anymore

Under current law, if you sell property that has been owned and used as a principal residence for two out of the past five years, you can exclude up to $250,000 ($500,000 for joint filers) of the gain. This means you could buy a rental home or rental property and use it as such for years. As long as you moved into it and lived there for two years prior to a sale, you could exclude gain on it (except for depreciation).

Under the Housing Assistance Act of 2008, as of January 1, 2009, the gain allocated to this period of nonqualified use will no longer be excludable. Hence, if you have property used as a second home (e.g., vacation home) or in a rental activity that you some day plan on converting to your principal residence, you may be affected by this new provision. To avoid these new rules altogether, you can sell the property before January 1, 2009. These new rules are very complex, so it’s important to talk to your tax professional before converting or selling. It could make a big difference on your tax return.

Related IRS Publications: 523