You may have heard this term before "principal residence" or "primary residence" but not really understood what it meant. This is usually referred to when talking about capital gains taxes. If you sell a house you can take advantage of the tax exclusion as long as the property is your principal residence. You might think that just because you live in the house it's your primary residence, but that may not always be the case. And unfortunately, there's no real definition provided in the tax code when it comes to capital gains taxes. Even the IRS themselves admitted that it depends on all facts and circumstances in each case including the operability of the taxpayer.
Most of the time principal residence refers to homeowners that have lived in the property two out of the last five consecutive years. If this is the case, you can usually benefit from the tax breaks available to you. But, it all depends on if you're selling your home as your principal residence. If you've lived in the home for several years and consider it your primary home, there's probably no question. But, if you've moved out of your house and have been renting it for some time you may not be able to claim the property as your principal residence.
Again, the IRS states that "the mere fact that property is, or has been, rented is not determinative that such property is not used by the taxpayer as his principal residence." [Source]
So why does this matter? Well, let's say that you've lived in the home for some time and buying the home is the easy part, selling it not so much. So rather than risk the financial burden of carrying two loans, you decide to rent out the old one or the new one until the old one sells. So, in this case, is it not your primary residence if you decide to occupy the new home instead of the current one you are trying to sell?
Well, the courts have not really upheld that a taxpayer is required to occupy the old property on the date of the sale. They may have to look at particular facts and on a case-by-case basis. If you can prove that you've tried to sell your old house but were unable to do so because of the market, there should be no questions that the home will still be considered your primary residence for tax purposes. However, there is a time limit. If you decide to hang on to the home for several years, you may run out of that grace period.
Of course, there is also the factor of profit. If you take up to the $500,000 tax exception for married people but you make more than that, you may want to consider doing a 1031 exchange instead to save you any excess taxes above that $500,000. It's important to talk to your real estate agent and your tax professional when deciding on selling a property over a half $1 million.
For more answers to your questions on primary or principal residency or buying and selling throughout Portland and Vancouver don't hesitate to give us a call. We are the team to get things done.