Until very recently if you lived in any home for 2 of the last 5 years you could avoid capital gains taxes. This was a nice loophole for properties that once generated cash flow. It meant that you could buy a rental property allow it to generate income and then live in it for 24 month to avoid paying capital gains. For a single person the exclusion pertained to any gain up to $250,000. A couple could exclude up to $500,000 from capital gains.
However attached to a new bill for mortgage relief is a provision that prohibits this exclusion. For example, say a couple buys a second home in 2006 to use as their vacation home. Three years later, in 2009, they sell their primary residence and move into the vacation home, making it their main home. They sell that home in 2011, realizing a gain of $200,000. Under the proposal, 20% of the gain, or $40,000 (one year of nonqualified use after 2007 divided by five years of ownership), isn’t eligible for the capital gains exclusion. The other $160,000 can be excluded from income because the two-year usage and ownership tests were met.
Read the full article here. And make sure to consult your accountant in the future when selling a second home or rental property.