Reduced Principal Residence Home Sale Exclusion for Non-Qualifying Use Beginning January 1, 2009

Currently, taxpayers are allowed to exclude up to $250,000 ($500,000 on a married filing joint return) of gain from the sale of their principal residence. Generally, taxpayers must own and occupy the residence for at least two of the five years preceding the date of sale. A reduced exclusion is permitted for taxpayers who meet certain unforeseen circumstances.

Under the Housing Assistance Tax Act of 2008, taxpayers will not be allowed to exclude any gain attributable to a "nonqualified use." This will prevent taxpayers from selling a second home or vacation home and excluding all the gain even if they meet the two-out-of-five years ownership and use tests.

For purposes of determining the amount of gain that is allocated to periods of nonqualified use, gain will be allocated based on the following ratio:

1. The aggregate periods of nonqualified use during the period the property was owned by the taxpayer.

2. The period the property was owned by the taxpayer.

The amount of gain allocated to periods of nonqualified use is the total amount of gain multiplied by a fraction (1) the numerator of which is the aggregate periods of nonqualified use during the period the property was owned by the taxpayer, and (2) the denominator of which is the period the taxpayer owned the property.

A period of nonqualified use is any period beginning January 1, 2009, during which the property is NOT used as the principal residence of the taxpayer, the taxpayer's spouse, or former spouse. Since the definition of a period of nonqualified use doesn't include any period before January 1, 2009, a taxpayer can avoid this new rule if he moves into another residence he owns and makes it his principal residence before January 1, 2009. A period of nonqualified use does not include any portion of the five-year testing period which is after the last date that the property is used as the principal residence. Therefore, any period after the last date the property was used as the principal residence (regardless of use during that period) is not taken into account in determining periods of nonqualified use. This new law is effective for sales and exchanges beginning January 1, 2009.

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