Academic journal article Journal of Accountancy

Sec. 121 Gain Exclusion Does Not Offset Suspended Passive Losses: Qualifying Taxpayers Who Convert a Principal Residence to Rental Property and Sell It Can Exclude Gain under Sec. 121 without Offsetting Any Passive Losses Carried Forward

Academic journal article Journal of Accountancy

Sec. 121 Gain Exclusion Does Not Offset Suspended Passive Losses: Qualifying Taxpayers Who Convert a Principal Residence to Rental Property and Sell It Can Exclude Gain under Sec. 121 without Offsetting Any Passive Losses Carried Forward

Article excerpt

The IRS concluded in a Chief Counsel Advice memo (CCA) that excluded gain from the sale of a former principal residence that was converted to rental property is not an item of passive activity gross income and, as such, does not offset any suspended passive losses upon disposition of the property.

Under the scenario outlined in the CCA, after owning and using a home as a principal residence for at least two years, a taxpayer converts it into rental property. The property, the taxpayer's only passive activity, generates nondeductible passive losses during the next three tax years. Each year's passive loss is suspended and assigned to the following tax year. Within three years of the property's conversion to rental property, it is sold at a gain that exceeds the suspended losses. The gain is excluded from gross income under Sec. 121(a).

Under Sec. 121, up to $250,000 for single taxpayers ($500,000 for a married couple filing jointly) of gain from the sale or exchange of a qualifying property may be excluded from gross income. The property must have been owned and used as the taxpayer's principal residence for periods totaling at least two years during the five-year period ending on the date of the sale or exchange. …

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