 Hello and welcome to this session in which we will discuss the sale of the taxpayer principal residence, which is your own home, section 121. In my opinion, this is one of the most generous tax law that the US government, the Congress grant to taxpayers. I did use this section 121 in the past in year 2006. Soon I might be selling my home. I might use it again in either 2022, if not 2022, most likely in 2023, I will be selling my home and I will take advantage of this exclusion. This is a non-taxable, non-taxable gain. So this topic, I just want to make sure we are aware of it, it falls under the third or non-taxable gain. Specifically, this gain will be non-taxable. It will not be the third. The Congress is that generous when it comes to taxpayer when they sell their home, which is their personal residence. Before we proceed any further, I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true, false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. So let's go ahead and get started. A taxpayer who sells his principal residence at a gain is eligible to exclude from his or her income part or total gain, depending on the amount of the gain, provided some conditions are met and we're going to see what the conditions are and what the amounts are. To be eligible, the taxpayer should have owned and used the property at his or her principal residence at least two of the last five years prior to the date on which the sale transaction was completed and closed. Simply put, you have to live in that principal residence, use it as a principal residence two of the five years of the past five years. For married, filing, and only taxpayer either spouse meet the ownership. Remember, you have to own it and live in it. If you are married to qualify, only one individual has to meet the ownership test. However, both spouses have to meet the use test, the use test requirement. Let's assume I bought a home in 20x1, 20x1, and let's assume January 1st, January 1st, 20x1, year one. And I lived in it, 20x1, 20x2, 20x3, 20x4. Now on 20x4, at the end of 20x4, December 31st, I get married. My wife and I started to live in this property, 20x5. We live in the property only for one year together, 20x5. Then we decided to sell. Now, as far as the ownership, I own the property two of the past five years. So only one individual will have to own the property. So even if I did not add my spouse to the ownership, that's fine. It's okay. I meet the ownership property. However, we both did not live in the property for two years. We only lived for one year, then we sold it. Therefore, I will meet only the execution for a single and I would only be able to deduct from the gain, execute from the gain 250,000 Y, because I lived with my wife only one year. So we did not meet the use requirement. If we met the use requirement, if we waited until 20x6 and we lived there 20x6, then we sold the property, then we would be considered married filing jointly for this execution and be able to execute half a million. Just be aware of this small trick. Also, if you are widow or widower, just want to make sure you understand also married filing single and head of a household, they get the 250,000. However, taxpayer filing as a widow or widower is eligible for the full execution as married filing jointly. If the residents, the person that lived there, owned and occupied it with the decedent spouse when the decedent spouse was sold within two years after the date of death. So two years after the date of death, as long as you guys live together at the date of death, you would qualify. It's important to note that the period of ownership does not need to be continuous. In other words, non-qualify uses of the property are permissible, but they reduce the amount of the execution available and we would look at the non-qualified uses later on. How does it work? So you don't have to be there for continuously, but you may get something called non-qualified uses. In contrast to involuntary conversion, the taxpayer are not required to replace the property to benefit from the gain execution. So let's assume I sold my home. I don't have to buy another home to get the gain. I can sell my home, take the gain, the 250 or half a million gain, whatever that amount is, was executed, deposit that money in my personal account and rent. I don't have to buy a home to qualify. So keep that in mind. It's not like involuntary conversion, what I have to replace the property. In addition, taxpayer may benefit from such execution several times during their lives. I already told you, I already did this in 2006 and I may go through this in 2023, provided that I need the ownership and the use requirement. So this execution is renewable. Now there are some hardship provisions. What are the hardship provisions? Well, let's assume you had to sell your home for reasons that are beyond your circumstances. Then you do have a hardship provision. A taxpayer who sells his principal residence before completing the two-year ownership and use may be eligible for a partial execution if the sale was due to change of employment, his or her employment and his or her employment. And the new job has to be greater than 50 miles from your residence. A health condition, you have a health condition or significant enforcing event or events, such as involuntary conversion, natural disaster, for example, the Eon hurricane right now. I'm pretty sure a lot of people will have to sell their residency. A divorce might qualify, multiple birth resulted from the same pregnancy could qualify as well. That's a good problem to have, right? This is referred to as the hardship provisions. Under this provision, the way it works, the amount of the reduced execution is computed by taking the exclusion available, and that exclusion available could be 250 or 500,000 depending on whether you are considered single or married, filing jointly, times a ratio of the number of months over which the taxpayer has owned and occupied the property over 24. Why over 24? Because remember, you have to live there for two years. And don't worry, we'll look at an example. And this is what the ratio would look like. Total execution available times by the number of ownership and use divided by 24, because you live there less than two years. Let's take a look at an example. Marsh first, Robert, a single taxpayer and Marsh first X3 acquired property for 580. After occupying the property for one year, he was diagnosed with a severe heart disease. He decided to sell his property and purchase a new one near a hospital with a heart disease specialization. Now, Robert sold his residency, Marsh second, a year later for 915. The property went up substantially, including brokerage commission of 12,000. It means he had to pay the brokerage commission. Now, let's compute the amount of realized gain and the execution as well. Determine the amount of gain, if any, Robert may exclude. Well, let's first compute the gain. A single taxpayer is eligible for 250. However, since he lived there for one year and he moved out, but he qualified under the hardship provision, he's qualified for partial exclusion. Well, let's take a look. What's the partial exclusion? 250 multiplied by 12 over 24. He lived there 12 months out of the 24 to qualify for the fall, which is 125. Now, let's determine the amount of gain to be recognized. Amount realized is 915 minus the selling expense. Remember, if there's any selling expense you deducted equal to 903, so commission is considered a selling expense, then less adjusted basis. Remember, the adjusted basis could be different than 580 in case you have a capital improvement. We'll have a realized gain of 325. So this is the realized of this amount. We can execute 125 and remainder 198 is taxable. This amount is taxable. So the total gain, the total gain is 323. The amount that's taxable is 198. That's pretty generous. Now, if Robert lived there for another year, then he will be able to get the full exclusion. Let's discuss the non-qualified use. This law started after January 1st, 2010. And non-qualified use occur when the taxpayer uses his home for purposes other than principal residence. For example, rent before meeting the two-year requirement. So this rental period, let's assume you rented your property, is not considered a period of disqualified as long as it occurs after the last day the home was used as the taxpayer principal residence. Simply put, if you met the two out of the five-year period, then you rented, that's different. But simply put, if you rented in between, so this, remember this two-year, if you rented it in between, so let's assume you lived there for one year, rent, then lived there another year or two more years. So notice what happened here. Before you met the two-year period, you rented the property. So this is, it will be considered disqualified. But after assuming you lived there one, two, three years, then you rent, then you sold, then you rent for one year, then you sold, it's fine, that's not disqualified because you could rent your property after you have met the two out of the five-year period. For non-qualified use, the gain eligible for section 121 execution is reduced. Let's take a look at the formula, the amount of the gain that's not eligible for the execution. How is it computed? Well, we look at the gain realized, we compute this, then we multiply this by the ratio of the number of years of non-qualified use over the total number of years of which the taxpayer owned the property. Now, it doesn't have to be years, it could be in terms of month is, but the point is it's the period prorated. So the gain eligible for the execution, well, gain realized, we compute this and we multiply it by this ratio, which is, again, number of month of non-qualified use with number of month, number of years, which is the time of non-qualified use divided by the total month of ownership, and this is the ratio. So the realized gain times this ratio. And the best way to illustrate this is to look at an example. January 1st, David, a single taxpayer, acquired the property for 650. He lived in that property for one year, then moved in with his friends, to his friend's place and rented his property to a tenant for two-year period. January 1st, Robert moved back to his own property where he lived for the whole year. Now, so what happened is this, he lived there 20x4, okay, then he moved out 20x5 rent, he rented the property 20x6 rented 20x7 lived there. So lived there for one, two years, so but notice, he did not, before he qualified for the two out of the five year, he rented the property, he rented the property here. So what's going to happen is this, and he sold it January at 20x8 for 225 for a gain of 225. So this is where we're giving the gain here. What's going to happen is this determine the amount of gain, if any, that's not eligible. Yes, some of it will not be eligible. That's correct. Robert used the property for a total period of four years, out of the four years, there are two years that are considered non-qualified years. Therefore, the gain realized by David is not eligible under the section 121 and it should be reduced. What should we do? The gain is 225, which we are given, multiplied by two out of four. Remember, we just, this is because we have the years of its month, we have the pro rate by month. So the gain that's not eligible is 112,500. Determine the amount of the gain that's recognized. Well, obviously, the gain realized by Robert from the sale is 225. Of that 225, he's eligible for 250 in total, but we're going to be reducing it by 225 will be reduced by 112,500. Therefore, what's left, half of the gain is recognized, half of the gain is tax free. So he qualified for a total of 250, but he did not have a gain of 250, he have of 225. And what's going to happen? We're going to split it in half. Part of it is taxable. Taxable will be 50% of it, and non-taxable, which is subject to section 121, 50% of it. That's still not bad. That's still not bad. But what should have David did is lived in the house for two years first, meet the qualification, then rent it and sell it within the qualified period. That would have been a better option. And this is where the tax advice will be very beneficial. That's why you should always talk to a CPA before we make making such moves. What should you do now or EA? Go to far hat lectures, whether you are a CPA or an EA candidate or a college student and look at additional resources, work, MCQs, true, false, that's going to help you understand this topic. This is an important topic. It's tested on the CPA exam because, as you might know, many people sell their home. So it's a common occurrence in the real world. Therefore, the CPA will test it, the EA will test it. And as a college students, you need to be familiar with this. Good luck. Stay safe. The CPA exam is worth it.