Rental house... move in for 2 years - non taxable?

[heyduke]

Okay here is the question.... I have a rental house... it has been rented and depreciated since 1994 (gawd I love this country) ...now what i need to know... correct me if I am wrong. If I move into the rental house for 2 years starting today when I sell the home there it will be a non-taxable capital gains event ... correct? In other words... I sell the home for 120 K and assume the cap gains is 20% (i know, i know...) that means if it is fully depreciated and I move in and claim it as my principal domicile I can avoid paying the 24 K cap gains. Or in effect get paid 1k for each month for 2 years to live in the house...


okay, what an i missing?

 

[harley]

They changed the law in 2008. The tax break is now prorated. If you move in in 2009, live there for 2 years, then sell, you'll only get 2/3s of the tax break. If you stayed for 10 years, then sold, you'd get 10/11ths of the tax break. This screwed up my plans too, but that's the way it goes.

Also, and this isn't something I know about, don't you have to repay the depreciation when you sell? Or is this negated by it being your primary residence at the end?

 

[Rich]

Harley:

Could you please go into more detail about this change in the law. Are you saying that the "two years out of five" rule of living in a home to avoid capital gains taxation is no longer valid?

Rich

 

[Martha]

The two years out of five rule still exists, it is just modified to address the issue of converting property you own into your home from another use.

You always had to recapture depreciation and you still do.

 

[harley]

Affirmative, when converting from a rental to a primary residence. At least the way I understand it. The tax code is in section 121, but I have a hard time understanding the legalese. From a web site that uses plain English:

A potentially expensive new regulation will affect taxpayers who convert property from business or rental use to a primary residence after Jan. 1, 2009. Even if the two years' residence test is met before sale, a portion of the profit will be taxable in proportion to the ratio of business vs. personal use.

For example, if you bought investment property on Jan. 1, 1999, convert it to your primary residence on Jan. 1, 2011, and sell it on Dec. 31, 2018, for a profit of $200,000, you will owe tax on $40,000, or 20 percent of the profit, because for two of the 10 years' ownership after Jan. 1, 2009, the property was not used as your primary residence.

Here's the web site (In the Money: Tax law changes for 2008 and beyond (maybe) | SeacoastOnline.com). I just googled the subject and chose one. I got the original info from my CPA last year when I was discussing some plans.

If anybody else reads this differently, let me know. I'd love to be wrong.

 

[Martha]

Here is a thread that talked about the change in the law: http://www.early-retirement.org/for...rting-rental-to-primary-38369.html#post707319

 

[TomCat]

So?? Law is unchanged (ie 2 of 5) if you have owned but not rented...ie if you have two residences?

I always planned on soem planning before I sell one...Tom R

 

[heyduke]

thanks for the responses and web links... but not necessarily for the bad news...

 

[calmloki]

thanks for the responses and web links... but not necessarily for the bad news...

You druther hear it from the Feds? It kinda fouled a cunning exit plan I had as well....

 

[heyduke]

You druther hear it from the Feds? It kinda fouled a cunning exit plan I had as well....

remember...ignorance is bliss

really screwed up my exit plan as it will add about 6 months to my future retirement date in order to make up the taxable portion of the rental in question.

 

[ChrisC]

If you're trying to avoid the capital gains and recapture of depreciation, consider doing a starker exchange of the rental into the dream house you might be purchasing a year or two before retirement; renting out the dream house for a year and then moving into the dream house upon retirement. It's a plan I'm seriously considering for sheltering appreciation gains on a rental property -- I have a few years to go in my plans. The downside is that you have to find the rental/dream property for Starker purposes. This is the only way I think you can avoid capital gains and recapturing the depreciation.

 

[harley]

If you're trying to avoid the capital gains and recapture of depreciation, consider doing a starker exchange of the rental into the dream house you might be purchasing a year or two before retirement; renting out the dream house for a year and then moving into the dream house upon retirement. It's a plan I'm seriously considering for sheltering appreciation gains on a rental property -- I have a few years to go in my plans. The downside is that you have to find the rental/dream property for Starker purposes. This is the only way I think you can avoid capital gains and recapturing the depreciation.

I did a 1031 (Starker) a few years ago on some investment property, then ended up building a house on the new property, and living part time in it. I recently was talking to my BIL (PhD in Economics) about it, and he said that I would have to subtract the taxes I saved on the exchange from the profit on the house sale when I finally do sell. I don't think so. I don't know if he's right, and intend to pretend I ever had that conversation. But I'd be interested in knowing who is right. Any idea?

 

[harley]

So?? Law is unchanged (ie 2 of 5) if you have owned but not rented...ie if you have two residences?

I always planned on soem planning before I sell one...Tom R

I don't think so. I think you are required to have one primary residence. If you own a second home (I do) you are still only allowed the full exemption on the primary. My plan was to live in one for about 10 years, sell it, pocket the full profit (up to $500K ), live in the second one for however long (over 2 years), sell it, pocket the full profit again, and so on. But the way it was explained to me by my CPA, I'd only get the tax break on the percentage of years the second home was my primary residence. If I sold again after 5 years, I'd only get 33% of the tax break because it had only been my primary residence 5 out of 15 years. I believe that is right.

Of course, I don't have too much to worry about anymore since I suspect I might break even on the primary after 10 years.

 

[ChrisC]

I did a 1031 (Starker) a few years ago on some investment property, then ended up building a house on the new property, and living part time in it. I recently was talking to my BIL (PhD in Economics) about it, and he said that I would have to subtract the taxes I saved on the exchange from the profit on the house sale when I finally do sell. I don't think so. I don't know if he's right, and intend to pretend I ever had that conversation. But I'd be interested in knowing who is right. Any idea?

Not an accountant and never had this situation personally; however, it seems that the gain or profit on the sale of the exchanged property takes into account the prior cost or tax basis in the initial property, which I believe gets adjusted to take into account any prior depreciation. So in a sense your BIL might be right if he's saying "taxes saved" means the prior depreciation you took on the old property. I think the only way you avoid depreciation recapture, which has separate tax rules, is if you never sell the exchanged property, which is part of my plan.

This area is above my pay grade so I'd turn to a real professional in this area. Let me know what he tells you.

 

[Martha]

May I suggest reading this article? Section 121: Changes to Section 121 ("121 Exclusions") by the Housing and Economic Recovery Act of 2008

Some important points:

1.Homeowners no longer can take the full tax-free exclusion on the sale of real property that was held and used as their primary residence if there was any non-qualified use of the real property prior to it being held and used as their primary residence.

Qualified use is defined as any use of the property as a primary residence. Non-qualified use is defined as any use of the property other than as a primary residence, including use as a second home, a vacation property, a rental or investment property or use in a trade or business.


2.The modifications made to Section 121 do not affect homeowners that move out of their primary residence and convert it to non-qualified use. The homeowner can still take the full amount of the 121 exclusion upon the sale of the property as long as they still qualify for the 121 exclusion.


3. Any and all non-qualified use of the property prior to January 1, 2009 will not be taken into account and is ignored for 121 exclusion treatment; only the non-qualified use of the property after December 31, 2008 will affect homeowners.


About the only thing to do is do a 1031 as Chris described and the make the property into your homestead. Then never sell it. Your heirs will get a nice stepped up basis and no one ever pays the tax on the depreciation and gains.

 

[ChrisC]

May I also suggest you read this article which covers 1031 exchanges when joined with the 121 exclusion:USING 1031 EXCHANGES AS A RETIREMENT PLANNING TOOL : Estate Planning Article by First American Exchange Company

 

[heyduke]

May I suggest reading this article? Section 121: Changes to Section 121 ("121 Exclusions") by the Housing and Economic Recovery Act of 2008

Some important points:

1.Homeowners no longer can take the full tax-free exclusion on the sale of real property that was held and used as their primary residence if there was any non-qualified use of the real property prior to it being held and used as their primary residence.

Qualified use is defined as any use of the property as a primary residence. Non-qualified use is defined as any use of the property other than as a primary residence, including use as a second home, a vacation property, a rental or investment property or use in a trade or business.


2.The modifications made to Section 121 do not affect homeowners that move out of their primary residence and convert it to non-qualified use. The homeowner can still take the full amount of the 121 exclusion upon the sale of the property as long as they still qualify for the 121 exclusion.


3. Any and all non-qualified use of the property prior to January 1, 2009 will not be taken into account and is ignored for 121 exclusion treatment; only the non-qualified use of the property after December 31, 2008 will affect homeowners.


About the only thing to do is do a 1031 as Chris described and the make the property into your homestead. Then never sell it. Your heirs will get a nice stepped up basis and no one ever pays the tax on the depreciation and gains.

now you have me thinking... keep it... take a reverse mortgage out on it and then what?