Recently, I have come across this scenario multiple times. I have a client that is an owner-occupant of a multi-family and wants to sell, but assumes they are eligible for the $250,000 tax exemption in gain for single person and $500,000 for married couples filing taxes jointly. Unfortunately, what people do not know is that if they are renting out the units in the building, that exemption is only allowed to be used on the percentage of the home that was used by the owner.
For example, if you are single and currently living in a 3 family property. You go to sell that property after living there for two years and expect to be able to use tour tax exemption and not pay any capital gains. You would only be able to use that exemption towards 33.3% of the gain.
The percentages will change in regards to the number of units. If you live in a two family, you would be able to use 50% of the exemption on the gain. If you were to a four family, you would be able to use 25% of the exemption on your gain.
There are ways around this, if you find yourself in certain situations. The easiest way to avoid not being able to use the entire exemption in the gain is to not rent one or the remainder of the units for a two-year period while living there. If you are the only occupant of the building and are utilizing the entire space, you would be eligible for the entire exemption on your gain.
I have had that conversation with numerous sellers nearing retirement who had no idea they were eligible for the entire exemption, not knowing the two year rule. They would have tenants for so many years, and decided against renting once they reached a certain age and didn’t want to be a landlord anymore. Now, they are able to compensate those years of not renting with this tax rule.
I also recommend speaking with an accountant if you fall in this category. They will be best to help maximize the percentage of your exemption you are allowed to use in your gain.