BIG change to capital gains exemption for San Diego real estate
December 7th, 2008 Categories: Real Estate News, San Diego county Real Estate News, Triathlon Club of San Diego Race Reports
SAN DIEGO– Yesterday at the Triathlon Club of San Diego duathlon in Carlsbad, I was approached by a fellow club member with a real estate 
question. His question pertained to a new tax law effecting the capital gains tax exemption when moving back in to a second home thus making it a primary residence under tax law.
See in the past, a home that you owned and lived in for a 2 year period, not needing to be consecutive, out of the last five years was looked upon as a primary residence. This allowed single people to write off up to $250,000 in capital gains and married couple, there is a time requirement and parameters for the marriage, to write off up to $500,000.
Now granted in most areas of the country it could take a homeowner many years, if ever to max out this deduction, but here in San Diego it was very doable in the period of 2001 to late 2006 early 2007.
Being the clever people that we are, many realized that this was a perfect time to unload that vacation or rental property and walk away with a nice junk of changes. What would happen, is that the owner would rent out the home they wanted to keep, move into the second property, live in it for about 20 months, put it on the market making sure escrow closed after the two year requirement and BINGO, exemption on gains. They would then move back in to their initial home and live happily ever after. Or, there were those that parked the gains from the second home, waited two 
years to sell the first home, pocketed the gains from that home and bought the house on the beach with the proceeds from the two or more sold homes. This gave them a lot of cash and worked within the tax laws.
Well, congress saw this as taking advantage of a loophole and closed this with an overlooked provision on page 690 of the 694 page 2008 Housing and Economic Recovery Act. To be honest with you, until my fellow club member brought this up, I had not heard of this change. See I, like many others, were focusing on what the act contained dealing with FHA loan limits, one of the initial mortgage bailout plans and money that was to be dispersed to cities to help maintain foreclosed properties avoiding blighted neighborhoods. After all, foreclosures and short sales rule the day right now.
So what does page 690 change? Well this is a bit unclear as I write this because again it has been a bit overlooked. It is one of the few things regarding our current real estate climate where you have to drill down on GOOGLE searches to come up with anything, but here is the very important overview.
Starting on January 1, 2009 the gains will be prorated. What I have not been able to yet confirm is if the law is retro or that 1/1/2009 is the start date. I believe the proration will start from that date meaning if you were to move into your rental property on 12/31/2008, sold it for a $350,000 gain as a married couple on 1/2/2010, you would see the exemption for the entire $350,000. Under the other scenario, say you owned the house as a rental for exactly 5 years from 12/31/2008 and followed the same parameters as above, you would owe gains tax on approximately $250,000 as this would be the proration of 5 years as a rental out of a 7 year ownership period. Either way, which I will keep working towards the answer on so check back, the proration of your gains will be the case going forward.This law will apply towards vacation homes also.
Why this is so important? Besides the fact that you could lose many thousands of dollars, if you had this built in to your retirement strategy you need to reexamine your strategy due to the new tax implications. You may want to move back into that home as close to 1/1/2009 as possible and 
live there for the two years to maximize your value. This would be especially true if you have long term plans for the home your in now. The longer you live there the less impact the new law will have, because remember, when you move out of that one, it will become a second home and fall under these guidelines. But if it is two years out of the next 20, this is not too bad.
You can always use the 1031 exchange method to sell rental property in order to avoid gains, but this just moves your proceeds in to another property. The beauty of the old law was that it gave you a way to convert that investment back to cash.
If you have any questions please seek advice from your tax preparer or financial planner.
See “Housing and Economic Reform Act of 2008″ as it was finalized into law. The link is given above: the ratio is only effective for periods starting Jan 1st 2009.
Specifically, section 3092 states:
“(C) Period of nonqualified use.–For purposes of this paragraph–
“(i) In general.–The term `period of nonqualified use’ means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used as the principal residence of the taxpayer or the
taxpayer’s spouse or former spouse.
sorry, a public link to the act as signed into law is at:
ttp://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_public_laws&docid=f:publ289.110
Thank you Paul!!!
So, does this mean the use of the property prior to 1/1/09 does not matter at all? We have a primary residence we have been trying to sell (we moved out of state for a new job), but are considering renting if it does not sell. If, say, we rent it for 2 yrs (beginning in 2009) and then sell it, is the capital gains ratio counted as 2/5 or 2/2? Hypothetical examples applying to this new law that I have found online have been very fuzzy on this point.
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