Under the previous federal laws, taxpayers who lived in a property as their primary residence for two of the last five years preceding the sale, could exclude for tax purposes, up to $500,000 of capital gains if they are married.  Single taxpayers could exclude $250,000.

Effective January 1, 2009, the exclusion will change for sales of principal residences that were used as a second home or income property during any part of the ownership period that occurred after January 1, 2009.  For periods of ownership after that date, the exclusion from capital gains will be reduced by the amount of time the property was not used as the principal residence. The gain from the sale will be allocated between the periods when the property was used as a Principal residence and periods of non qualified use.  The tax will be calculated by multiplying the gain by a fraction where the top number is the period the property was used as a Principal residence and the lower number the total period of ownership.

Example:  If a married couple filing jointly purchases a vacation property on January 2, 2009, uses it as their vacation home for 6 years, moves into it for 2 years and sells it on January 2, 2017 for a gain of $600,000 they will be taxed as follows:

Multiply the $600,000 gain by 2 years of qualified use divide by 8 total years of ownership. ($600,000 x 2 divided by 8 is $150,000).  They may then exclude $150,000 of profit from capital gains taxes.  The remaining balance of $450,000 would be taxed.