How The Required Two-Year Period is Calculated

How The Required Two-Year Period is Calculated

How The Required Two-Year Period is Calculated One of the commonly misunderstood areas of the primary home exemption is how the periods are calculated to meet the ownership and use tests. For the average person who has owned and lived in his or her home for the past two or more consecutive years, there is usually no question of qualifying for the exemption.

However, calculating the period becomes a little more difficult in situations where the use has not been continuous, the exemption has been previously claimed, or where one of the spouses does not meet one of the tests. The general rule is that a taxpayer must have owned and lived in the home for two of the last five years. It does not matter which two of the last five years or that the two years are contiguous.

Example:
When Bob moved to Denver three years ago from Los Angeles, he decided to rent his Los Angeles home for a while instead of selling it. He had owned and lived in the Los Angeles home for many years, including the two immediately prior to moving to Denver. Bob recently completed the sale on the Los Angeles home and would qualify for the primary home exemption on the sale of that home.

Example:
Sally has had a beach house in New Jersey for 31/2 years. Two years ago she moved to New York City after having lived in the beach house as her main home for 18 months. She has continued to use the beach house on weekends and holidays while living in the city. Currently, she is planning to rent her city home and move back to
the beach house for 6 months and then relocate to the West Coast. After the 6 months back at the beach house, each of Sally’s homes will qualify for the exemption but not if both are sold within a 24-month period. Before Sally relocates, she intends to sell the beach house and use her primary home exemption to avoid taxes on the profit. She also plans to sell the city home 2 years later and use the primary home exemption again to avoid taxes on the profit from that sale. Sally will qualify for both exemptions because she will be able to show that she meets the criteria for both homes and did not try to use the exemption more that once in a 2-year period.

Example:
Before Don and Julie got married about a year ago, both owned their own home. When they got married, they decided to live in Julie’s home so Don sold his, using the primary residence exemption to shield him from taxes on the gain. Currently, Don and Julie have decided they need a bigger home and want to sell Julie’s house and relocate. The estimated gain on Julie’s house is $400,000; they plan to use the married couple primary residence exemption of $500,000 to shield them from taxes on the gain. Unfortunately, they do not qualify for the full married couple exemption because Don doesn’t meet either the ownership or the use tests. Julie does meet both tests and could file a separate tax return and claim her exemption, but that would only shield $250,000 of the $400,000 anticipated gain. Don and Julie’s two main alternatives are:

1. Wait one more year so they both qualify and use the married couple $500,000 exemption at that time.
2. Sell now using only Julie’s $250,000 exemption (filing separate tax returns) and pay the taxes on the other $150,000 of gain.

Don and Julie’s situation in the example above would not normally pose too much of a problem because it usually takes a few months to sell a home and locate a replacement. This means that Don and Julie can start the selling process in about nine months and time the closing of the property for a day or two after the two-year mark. In most cases, figuring whether a property (and taxpayer) qualify for the exemption is not difficult. If there are questions, be sure to discuss them with your tax advisor. Sometimes, however, a taxpayer simply does not meet the two-year tests but has no choice but to move now. In those situations, which will be discussed below, the regulations may allow a partial or fractional portion of the exemption to be taken.