How the Housing Assistance Act of 2008 impacts investors

Suppose the taxpayer had exchanged into the property in 2007, and rented for 3 years until 2010 prior to the conversion to a principal residence. If the taxpayer sold the residence in 2013, after three years as a principal residence, only the 2009 rental period would be considered in the allocation for the non-qualified use. Thus, only one-sixth (1 out of 6 years) of the gain would be ineligible for §121 tax exclusion.  Notably, the allocation rules generally apply only to time periods prior to the conversion into a principal residence and not to time periods after the conversion out of principal residence use. Thus, if at the time of the sale of the property it is a rental property but has for 2 of the last 5 years been a principal residence, the applicable exclusion need not be allocated. Accordingly, if a single taxpayer converts a principal residence into a rental property and never moves back in, and otherwise meets the two out of five year relinquished under §121, the taxpayer is eligible for the full $250,000 exclusion when the rental property is sold. This rule only applies to non-qualified use periods within the 5 year lookback period of §121 after the last date the property was used as a principal residence. Therefore, if the taxpayer used the property as a principal residence in year one and year two, then rented the property for years three and four, and then used it as a principal residence in year five, the allocation rules would apply and only three-fifths (3 out of 5 years) of the gain would be eligible for the exclusion under §121. A simple way to determine if the allocation rules of the Housing Act of 2008 may apply to a transaction is to determine if the property is a principal residence at the time of sale. If not, then the allocation rules do not generally apply. As a "Qualified Intermediary" as defined in the Section 1031 regulations, Asset Preservation, Inc. is not able to provide legal or tax advice. Accordingly, you should review the details of your specific transaction with your own legal or tax advisor. Pamela Michaels is an attorney and vice president of Asset Preservation, Inc., Manhattan, N.Y.