Capital Gains Tax Basis

The basis is essentially the price paid for property, plus the cost of capital improvements over time, less any depreciation that was (or could have been) deducted.

In this case the basis starts out at 100,000. Depreciation depends on several factors, but could be about $2500 per year. So after ten years the basis is reduced to $75,000, which is subtracted from the $150,000 sales price, leaving a $75,000 capital gain.

If the owner moves back into it for ten years and then sells it, capital gain up to the first $250,000 ($500,000 for a married couple) is tax free.

When Stu wrote in his next-to-last paragraph "...which is subtracted from the $150,000 sales price, leaving a $75,000 capital gain," I'm pretty sure he meant to write "...which is subtracted from the $250,000 sales price, leaving a taxable gain of $175,000."

That gain will be a section 1231 gain, and part of the gain will also be unrecaptured section 1250 gain, which is a topic waaaay beyond the scope of this thread.

Well, I would have meant that if I'd noticed the sale would be when the value was $250,000 instead of $150,000. Thanks for catching that.

RE: "If the owner moves back into it for ten years and then sells it, capital gain up to the first $250,000 ($500,000 for a married couple) is tax free. "

This is NOT correct. The entire period of ownership will be analyzed for "qualified" versus "non-qualified" use periods. Nonqualified use is any period after 2008 during which neither taxpayer nor spouse (or former spouse) used the property as a main home. The portion of the gain attributable to non-qualified period will never qualify for the gain exclusion, no matter how long you live in the house after the rental use.

Maria U. Ku, CPA Oakland, CA

I meant to write "two" years instead of "ten." Under Section 121, as long as the property was used as the principal residence if the owner (s) for two years out of the previous five (which will necessarily be after 2008 since that was more than five years ago), it will qualify for the exemption.

But you're right, section 121 was changed by the new tax act. If the property was not used as a principal residence from the beginning, the "unqualified" use time will proportionately reduce the amount of the exemption. But my understanding is that, if the home started out as a principal residence, subsequent unqualified use won't count against the exemption.

In OP's case they used the property as their principal residence for the first ten years of ownership, and converted it to a rental afterwards. It doesn't appear that any apportionment or reduction in the exemption would be warranted if they moved back in to qualify for it.

There are certain exceptions, most notably:

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 don't think Section 121 was changed by the new tax law.

And the conclusion stated in your last sentence is incorrect.

And no one has yet pointed out that $75,000 of gain (when the house is sold, after being used a principal residence for the second period of personal use) attributable to the depreciation taken on the house while it was a rental will not qualify for the $250,000 exclusion. Anybody disagree with that?

Maria pointed it out, without doing the math.

I don't disagree with your math, other than it ignores depreciation that has been or could have been taken, as well as any improvements. And the fact that OP does not say she moved back in and used it as her principal residence after the rental period. Or, if she did, how long that unstated period was, which would affect the pro ratio numbers.

I think the answer to OP's question is that then entire gain is taxable, and depreciation, and improvements must be taken into account. And possible depreciation recapture and unrealized 1250 gain.

OP makes no mention of a second period of principal residency. Stu added that. And the thread drift was complete.

I didn't say there had been a second period of residency. I suggested that as a way she could save some taxes.

Yes. But then everyone else assumed your suggestion were the facts.

I would like to point out that the denial of the Section 121 exclusion for any gain allocable to periods of nonqualified use on the one hand, and the denial of the Section 121 exclusion for gain attributable to depreciation on the other hand, are not the same thing.

They are two entirely different exceptions to the Section 121 exclusion, and they are applied based on quite different things. And they both might easily apply to the same scenario.