Dear Tax Talk,
I am currently living in a home in New Mexico that I purchased in February 2008. I own a home in Arizona that I am renting out through a management company. If I sold the house in New Mexico and kept the house in Arizona, would there be any penalty, taxwise, since I have been in the house in New Mexico less than a year? The reason that I would be moving back to Arizona is job-related. I have a VA loan on the house in New Mexico.
-- Dave

Dear Dave,
The general rule is that in order to exclude gain on the sale of a home, you have to have lived in it and owned it as your primary residence for more than two years within the last five years.

The New Mexico home would not qualify for gain exclusion under the general rules, since you've only owned it since February. If you do sell the New Mexico home at a gain (which would be surprising under the current market conditions) you have to look for an exception to the general rule in order to avoid paying tax on the gain. An exception for a job-related move allows a seller a reduced gain exclusion when they do not meet the two-year use and ownership test.

The sale of your main home is because of a change in your place of employment if your primary reason for the sale is a change in the location of employment. For this purpose, employment includes the start of work with a new employer or continuation of work with the same employer at a different location. It also includes the start or continuation of self-employment.

Job-related exclusion rules for home sale:

• The change occurred during the period you owned and used the property as your main home. • And the new place of employment is at least 50 miles farther from the home you sold than the former place of employment was.

Assuming you meet the distance test, you can claim a reduced gain exclusion on the sale of the New Mexico home. The reduced gain exclusion is based on the months you lived in the New Mexico home, divided by 24 months, multiplied by the maximum exclusion you could otherwise claim.

For example, if you're single, the maximum exclusion you could claim is $250,000. If you owned and used the New Mexico home for six months prior to returning to Arizona, your reduced exclusion is 25 percent of $250,000 or $62,500. If your gain on the sale of the New Mexico home is less than $62,500, you won't owe any income tax on the sale of the property. The type of loan on the New Mexico home does not affect the reduced exclusion.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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