The Housing Assistance Tax Act of 2008, signed into law on July 30, 2008, aimed to bolster the struggling housing market by offering tax breaks for homeowners and homebuyers. Among its provisions were new property tax deductions for non-itemizers and a first-time homebuyer credit. However, one often overlooked change was the reduced home sale exclusion for properties used both as a principal residence and as vacation/rental property.
Key Changes Introduced by the Housing Assistance Tax Act of 2008
The Act mandates that homeowners pay taxes on gains that reflect the portion of time the property was not used as their principal residence. The remaining gain qualifies for exclusion (up to $250,000 for single filers and $500,000 for joint filers). Previously, taxpayers could live in a vacation or rental property for two years, sell it, and take the full gain exclusion, even if the gain was attributable to the time the property was not their principal residence.
Implications for Divorcing Homeowners Moving into a Vacation or Rental Property
Under the Housing Assistance Tax Act of 2008, the IRS requires homeowners to pay taxes on capital gains for the period the property was not their primary residence, starting from January 1, 2009. This is particularly relevant 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, any gain from the sale of a principal residence is not excluded from income to the extent the property was used for a non-qualified use. Non-qualified use includes any period after December 31, 2008, when the property was not the taxpayer's principal residence.
To calculate the gain attributable to non-qualified use, multiply the total gain by the fraction of time the property was used for non-qualified purposes. Non-qualified use does not include any period after the property was last used as the principal residence or periods of qualified official extended duty or temporary absence due to employment, health, or other unforeseen circumstances (up to two years).
Example Scenario
John buys a home on January 1, 2016, for $400,000, uses it as a rental for two years, and then makes it his principal residence on January 1, 2019. He sells it on January 1, 2022, for $700,000. Since the first two years were non-qualifying, 40% of John's $300,000 gain ($120,000) is not eligible for exclusion. The remaining $180,000 can be excluded, but John must also include $20,000 of gain attributable to depreciation as ordinary income.
Impact of Investment Property Becoming a Primary Residence
The Act restricts gain exclusion when an investment property is converted to a principal residence. However, it does not restrict gain exclusion when a principal residence becomes a non-qualifying use property, provided this occurs after January 1, 2009. Therefore, moving into a rental property as a primary residence can have significant tax consequences.
Benefits of Working with a Certified Divorce Lending Professional (CDLP®)
A CDLP® brings a critical perspective to the divorce team, understanding the intersection of family law, tax law, real estate, and mortgage financing. This expertise ensures both spouses can secure new mortgage financing post-divorce.
Key Advantages of a CDLP®:
- Expert Guidance: CDLP® professionals provide deep insights and support during the divorce settlement process.
- Holistic Approach: Divorce Mortgage Planning integrates mortgage options with overall financial goals, minimizing taxes and interest expenses while maximizing cash flow.
- Informed Decisions: CDLP® professionals help divorcing homeowners make informed decisions about home equity solutions and mortgage financing.
Contact a CDLP® Today
For expert assistance in navigating mortgage financing during and after divorce, contact a CDLP®. Obtain the "Divorcing Your Mortgage Homeowner Workbook," a comprehensive guide to credit, real property, and mortgage planning post-divorce. This workbook helps you organize, prepare, and understand your mortgage financing options, whether refinancing the marital home or purchasing a new one.
About Divorce Mortgage Planning
Divorce Mortgage Planning is a comprehensive approach to evaluating mortgage options within the context of overall financial goals related to divorce. A CDLP® works directly with the divorce team to align mortgage decisions with long-term financial and investment goals, ensuring tax efficiency and optimal cash flow.
Conclusion
Involving a Certified Divorce Lending Professional (CDLP®) early in the divorce settlement process can set the stage for successful mortgage financing in the future. Ensure smoother transitions and better financial outcomes post-divorce by incorporating expert mortgage planning into your settlement.
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. The information contained in this newsletter has been prepared by, or purchased from, an independent third party and is distributed for consumer education purposes.
Copyright 2022—All Rights Divorce Lending Association
