Ethan (single)purchased his home on July 1, 2010. He lived in the home as his principal residence until July 1, 2017, when he moved out of the home, and rented it out until July 1, 2019, when he moved back into the home. On July 1, 2020, he sold the home and realized a $233,500 gain. What amount of the gain is Ethan allowed to exclude from his gross income?

Question

Quizplus · Accepted Answer

Ethan is allowed to exclude up to $250,000 ($500,000 if married filing jointly) of gain from the sale of his principal residence if he owned and lived in the home for at least 2 out of the 5 years before the sale. In this case, Ethan owned and lived in the home for 7 out of the 10 years before the sale. Therefore, he meets the ownership and use tests to qualify for the exclusion.

However, since Ethan rented out the home for 2 years before moving back in, he will need to allocate the gain between the period of time he occupied the home as his principal residence and the period of time he rented it out.

The period of time he occupied the home as his principal residence is 7 years (from July 1, 2010, to July 1, 2017) and the period of time he rented it out is 2 years (from July 1, 2017, to July 1, 2019).

To determine the amount of gain he can exclude, Ethan will need to use the following formula: 
Exclusion = (Total Gain) x (Period of Use as Principal Residence / Total Period of Ownership)

Exclusion = ($233,500) x (7 years / 10 years) = $163,450

Therefore, Ethan is allowed to exclude $163,450 of the gain from his gross income. The remaining $70,050 ($233,500 - $163,450) will be subject to capital gains tax.

Ethan (Single)purchased His Home on July 1, 2010