Rent then Reside

[RockMiner]

We expect to ER within about five years. This will involve downsizing into a lower cost home located in another city. An interesting option would be to purchase a house now that we would eventually like to live in, but rent it out untill we actually make the move. It seems to me this could be a good way to diversify our investments. It would somewhat kill two birds with one stone in
hedging against rising real estate prices in the new city. Appreciation potential is less   critical though since the rental would become our long term residence. Initially we would have to borrow to finance this "rental" house, but would pay it off when we move in. I'm not clear on the tax consequences of converting a partially depreciated rental house into ones residence. At this point it's just a fuzzy idea so I welcome constructive comments.

 

[Brat]

A great way to get answers from tax pros is to post your question on this website:

http://groups.google.com/groups?hl=en&lr=&ie=UTF-8&group=misc.taxes.moderated

Because this is a moderated forum it takes a couple days for postings to appear, but you have some assurance that the responses will be knowledgable and thoughtfull.

 

[Martha]

From IRS faqs found at www.irs.gov/faqs/faq-kw165.html:

I lived in a home as my principal residence for the first 2 of the last 5 years. For the last 3 years, the home was a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the depreciation I took while it was rented out?

If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years and lived in it as your main home for at least 2 years, you can exclude up to $250,000 of the gain ($500,000 on a joint return in most cases). However, you cannot exclude the portion of the gain equal to depreciation allowed or allowable for periods after May 6, 1997. This gain is reported on Form 4797. If you can show by adequate records or other evidence that the depreciation allowed was less than the amount allowable, the amount you cannot exclude is the amount allowed. Refer toPublication 523 , Selling Your Main Home and Form 4797 (PDF), Sale of Business Property for specifics on calculating and reporting the amount of the eligible exclusion.

References:

* Publication 523, Selling Your Home
* Publication 527, Residential Rental Property
* Publication 587, Business Use of Your Home
* Form 4797 (PDF) , Sale of Business Property

Nice and straightforward, eh?

 

[MJ]

My primary residence is a 2 family house. I live in one apartment and rent out the other.
Am I correct in my understanding that the following are true,
1) if I continue to rent up to the date of sale I can exclude 1/2 of the $250,000 or $125,000 gain.
2) if I stop renting the last 2 years before the date of sale I can exclude to full $250,000 gain.

If #2 is true, it would be better for me to stop renting as I would get back a lot more the the rental income for 2 years. There would probably be other benefits having lower heat, water and other related tenant expenses and would deliver a house without the complications of a tenant.

MJ

 

[Martha]

My primary residence is a 2 family house. I live in one apartment and rent out the other.
Am I correct in my understanding that the following are true,
1) if I continue to rent up to the date of sale I can exclude 1/2 of the $250,000 or $125,000 gain.
2) if I stop renting the last 2 years before the date of sale I can exclude to full $250,000 gain.

If #2 is true, it would be better for me to stop renting as I would get back a lot more the the rental income for 2 years. There would probably be other benefits having lower heat, water and other related tenant expenses and would deliver a house without the complications of a tenant.

MJ

Based on my understanding, you are not quite right. Currently, assuming the two units are identical, you should be depreciating half of the value of the building (land doesn't get depreciated). If you stay living there up until you sell, your purchase price gets allocated one half to your rental unit ( your home) and one half to the rental unit. You would have to pay tax on any gains from the rental unit, over and above the depreciated basis.

Using oversimplified numbers, if you bought for $500,000 dollars, and sold for a milllion with no costs, the tax on your unit would be zero (500,000 sale price on your unit less 250,000 basis, net is 250,000 which is exempt from tax). The tax on the rental unit would be based upon the net purchase price attributable to that unit (500,000) less the depreciated basis. To make it even more complex, the tax on the recaptured depreciation is at 25% and the remaining gain at capital gains rates.


If you want, I can go through the analysis of what happens if you quit renting out the other unit and make the whole thing your home, but I am not up for it at this minute.

Oh, this isn't legal advice, consult the appropriate professional or rely on yourself when it comes time to decide what to do.

 

[MJ]

Oh, this isn't legal advice, consult the appropriate professional or rely on yourself when it comes time to decide what to do.

Gee, I guess I can't sue now.

Thanks for the info.

MJ

 

[John Galt]

There are many grey areas in this, and you can read all you want, but much is ambiguous or worse. Interpret
the rules in your favor. In many cases no one really knows anyway. I am always amused by those who
go the other way, i.e. pay more than they owe
just so they won't have to explain themselves
to anyone down the road. Disclaimer: Consult your
tax professional before taking any of my advice.

John Galt

 

[Martha]

Oh, this isn't legal advice, consult the appropriate professional or rely on yourself when it comes time to decide what to do.

I figured I would get some flak for this, but every once in a while the cya comes out in me.

 

[haha]

I figured I would get some flak for this, but every once in a while the cya  comes out in me.  

I can't blame you. By the way, what is a cya?

Mikey

 

[Cut-Throat]

I can't blame you. By the way, what is a cya?

Mikey

I'll take this one Mikey - Cover Your Ass


You must be retired for a Long While

 

[haha]

I'll take this one Mikey - Cover Your Ass


You must be retired for a Long While

LOL, thanks for the answer and joke. Yeah, I guess I have. Long enough that I have never taken any kind of sensitivity or compliance training. And I am afraid it shows.

Mikey

 

[John Galt]

Hey Mikey! Never had sensitivity training either. I once considered assertiveness
training Anyway,
I have minimal experience with cya. I was almost
always on the offensive business-wise (take no
prisoners?). "cya" implies a level of stealth I usually chose to shun.

John Galt

 

[wzd]

My primary residence is a 2 family house. I live in one apartment and rent out the other.
...

The other question that comes to mind - What happens if you move to the second unit and rent the first unit for 2 years. Then you have lived in each one for at least 2 of the last 5 years. You still have depreciation recapture (whether or not you actually took the depreciation :-( ). Something to run past your accountant if you would be willing to do that! Sounds like a reasonable idea to me, but follow the usual get your own legal opinion mantra.

Wayne