Capital Gains Exclusion Pro Rata Rule for Rental to Residential Conversion

[Myriad]

Limits To Converting Rental Property Into A Primary Residence To Plan For IRC Section 121 Capital Gains Exclusion

“In addition to the limitation of Section 121 regarding depreciation recapture, as a part of the Housing Assistance Tax Act of 2008, Congress further limited the exclusion of capital gains for property that was converted from a rental to a primary residence. The new rules, enshrined in IRC Section 121(b)(4), stipulate that the capital gains exclusion is specifically available only for periods during which the property was actually used as a primary residence; any other time (since January 1st, 2009) that the property was not used as a primary residence is deemed “nonqualifying use”. Accordingly, to the extent gains are allocable to periods of nonqualifying use (gains are assumed to be pro-rata over the holding period), those gains are not eligible for the exclusion.”

Has anyone encountered this?

[SK in CV]

Yes. Many people have encountered it.

[Myriad]

Just curious, because that’s the first I heard of proration of Section 121. Very few financial planners/accountants seem to mention this rule, so would like some confirmation from the community.

[SK in CV]

It exists. It’s very real.

[Author]

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