The Housing and Economic Recovery Act of 2008 changed the tax rules around the sale of primary residences in a way that has not been widely discussed. Homeowners may no longer be able to claim a full $250,000 (or $500,000 for married filing jointly) capital gains exclusion for a primary residence despite living there for 2 of the past 5 years.
The new rules, which went into effect at the beginning of 2009, still use the 5 year look-back period. They also retain the exclusion limits of $250,000 and $500,000. However, sellers now need to scale the exclusion by the percentage of time that the property served as their primary residence over the past 5 years. A quick example is the easiest way to illustrate the change. Suppose an owner lived in a property for 2 years, then rented it out for 3, and is now looking to sell. Because they lived there for 2 of the previous 5 years, they would be eligible for 40% of the credit. Under the previous code, they would have qualified for the whole thing.
Like all laws, this can get complicated quickly. And portions could be open to interpretation. So, investors and second home owners planning to take advantage of this gains tax exclusion need to consult with their people (accountants and/or attorneys) to make sure that they are on track to achieve their real estate goals.
For Your Further Reading Enjoyment:
The Housing and Economic Recovery Act of 2008 (refer to Section 3092 near the end)
IRS Section 121 Code