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The Housing Assistance Tax Act of 2008, signed into law on July 30, 2008, aimed to bolster the struggling housing market by providing tax breaks for homeowners and homebuyers. Key provisions included new property tax deductions for non-itemizers and a first-time homebuyer credit. However, a less-known but significant change was the reduction in home sale exclusion for properties used both as a principal residence and as vacation or rental property post-2008.
Key Provisions of the Housing Assistance Tax Act of 2008
The Act mandates that homeowners pay taxes on gains reflecting the period when the property was not used as a principal residence. The remaining gain is available for exclusion (up to $250,000 for single filers and $500,000 for joint filers). Previously, a loophole allowed taxpayers to live in a vacation or rental property for two years, sell it, and claim the full gain exclusion, even if part of the gain was from when the property was not a principal residence.
Impact on Divorcing Homeowners
What happens when a homeowner moves into an existing vacation or rental property after divorce? The Housing Assistance Tax Act of 2008 impacts individuals and small businesses by prorating capital gains exclusion for periods of non-primary use. This is crucial for divorcing clients when one spouse retains an investment property to use as their new primary residence.
Calculating Potential Tax Liability
After December 31, 2008, gain from the sale of a principal residence will not be excluded from income if the property was used for non-qualified purposes, as defined under Code § 121(b)(4). This restriction applies to non-qualified uses after December 31, 2008. Non-qualified use refers to any period after this date when the property was not the taxpayer's principal residence.
To calculate the gain allocated to periods of non-qualified use, multiply the total gain by the fraction representing the aggregate periods of non-qualified use while the taxpayer owned the property divided by the total ownership period. Non-qualified use does not include periods after the last use as a principal residence, periods when the taxpayer or spouse was on qualified official extended duty (up to 10 years), or temporary absences due to employment changes, health, or unforeseen circumstances (up to two years).
Example Scenario
John buys a home on January 1, 2018, for $400,000, uses it as a rental property for two years (claiming $20,000 in depreciation), and starts using it as his principal residence on January 1, 2020. He sells it on December 31, 2022, for $700,000. The first two years are non-qualifying use, but the year after moving out is a qualifying use. Therefore, 40% (two out of five years) or $120,000 of John's $300,000 gain is not eligible for exclusion. The remaining $180,000 may be excluded, and $20,000 attributed to depreciation must be included as ordinary income.
Transitioning Investment Property to Primary Residence
The Act restricts gain exclusion when converting an investment property to a principal residence but does not restrict it when converting a principal residence to non-qualifying use. This provision applies only to non-qualified uses beginning January 1, 2009.\
Conclusion
Transitioning a rental property to a primary residence can carry significant tax consequences. Always discuss tax concerns with your attorney or financial advisor.
Working with a Certified Divorce Lending Professional (CDLP®)
Incorporating Divorce Mortgage Planning into the divorce settlement can help both spouses secure new mortgage financing post-divorce. Contact a CDLP® today for a copy of the Divorcing Your Mortgage Homeowner Workbook. This guide will help you organize, prepare, and understand your mortgage financing position, whether refinancing the marital home in an Equity Buy-Out or preparing to sell and purchase a new home post-divorce.
As a divorce mortgage planner, the CDLP® can help divorcing homeowners make more informed decisions regarding their home equity solutions while assisting the professional divorce team in identifying potential conflicts between the divorce settlement, home equity solutions, and real property issues.
Benefits of Early Involvement
Involving a Certified Divorce Lending Professional (CDLP®) early in the divorce settlement process can set the stage for successful mortgage financing in the future.
Disclaimer
This information is for educational purposes only and is not intended as legal or tax advice. Consult an attorney or tax professional for legal and tax advice. Interest rates and fees are estimates for informational purposes only and are subject to market changes. This is not a commitment to lend. Rates change daily – call for current quotations.
Copyright 2023 Divorce Lending Association. No portion of this post may be reproduced without written consent from the Divorce Lending Association.
This is for informational purposes only and not for the purpose of providing legal or tax advice. You should contact an attorney or tax professional to obtain legal and tax advice. Interest rates and fees are estimates provided for informational purposes only and are subject to market changes. This is not a commitment to lend. Rates change daily – call for current quotations.
Copyright 2023—All Rights Divorce Lending Association
