Methodology for withdrawing for retirement

[SecondCor521]

Can you find where this is stated? The only thing I've found so far is the following:

"The IRS realizes that a person’s circumstances may change; therefore, a property may change in character over time. For this reason, it is possible for an investment property to eventually become a primary residence. If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable."

So to me that seems to suggest I need to own the property as a primary residence for 5 years after converting, which seems doable.

I think it is buried somewhere in IRS Pub 523, probably in this section talking about non-qualified use after 2008:

Publication 523 (2023), Selling Your Home | Internal Revenue Service

www.irs.gov

See also the last two exceptions to the eligibility test step 5 - these conditions prevent you from automatically claiming the full $500K exemption, but you may qualify for a lesser exemption:

Publication 523 (2023), Selling Your Home | Internal Revenue Service

www.irs.gov

To be clear, I'm not an expert and am just relaying what I read over on Bogleheads. I searched over there for the threads but can't find the ones I'm thinking of.

 

[Lorenzo]

Can you find where this is stated? The only thing I've found so far is the following:

"The IRS realizes that a person’s circumstances may change; therefore, a property may change in character over time. For this reason, it is possible for an investment property to eventually become a primary residence. If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable."

So to me that seems to suggest I need to own the property as a primary residence for 5 years after converting, which seems doable.

That's what we have been doing after moving into our 1031-exchanged former rental property. Our CPA said five years may even be a minimum, and she recommended we live there even longer if we wish to avoid IRS scrutiny.

 

[Koolau]

Heh, heh, let no one suggest the IRS isn't diligent in getting the most taxes from us that it can. We were so fortunate to be able to take advantage of the "living 2 years out of 5" regulation (only issue was recapture of depreciation.)

Suggest spending the money to get a good tax attorney or other specialist to review your plans regarding selling your rentals. Could be money well spent because YMMV.

 

[orbops]

I would agree that selling your rental properties might be better since all that rental money is ordinary income. For the Marketplace, you have to keep your AGI low enough to qualify for subsidies, so all that rental income is inflating your AGI.

One possible red flag in your original post is that you have $1M for 9 years, and your expenses are $120K/year. If the market does well, you should be OK, but if the market has a few bad years, then $1M may not be enough.

 

[surprising]

I would agree that selling your rental properties might be better since all that rental money is ordinary income. For the Marketplace, you have to keep your AGI low enough to qualify for subsidies, so all that rental income is inflating your AGI.

Much of the rental income is offset by depreciation and expense deductions so there's little actual income reported.

One possible red flag in your original post is that you have $1M for 9 years, and your expenses are $120K/year. If the market does well, you should be OK, but if the market has a few bad years, then $1M may not be enough.

I did a simple model of selling enough of my dividend producing assets to cover $120K expenses every year assuming all my dividend stocks continue to pay the same amount (but diminishing each year due to selling), and it would take about 15 years to fully exhaust those assets. Its a bit optimistic as it assumes overall stock/fund prices don't change at all. But, it also only makes up about half of my current available assets, so there would be plenty of other funds available if the dividend funds got sold off before 10 years. Also if I'm in a bind I always have the rentals that I can sell.

 

[Koolau]

Have you considered serially living in your rentals for 2 years as you sell them off "slowly"? Then I think you could treat them all as personal residences for tax purposes. Of course, you would still owe the depreciation recapture (ask me how I know.)

 

[SecondCor521]

Have you considered serially living in your rentals for 2 years as you sell them off "slowly"? Then I think you could treat them all as personal residences for tax purposes.

This trick used to work but Congress enacted changes to curtail it. Look for "periods of nonqualified use" in IRS Pub 523.

 

[surprising]

This trick used to work but Congress enacted changes to curtail it. Look for "periods of nonqualified use" in IRS Pub 523.

If I'm reading it correctly, it looks like you can take a partial exclusion. You compute a non-residence factor (days used as rental after 2008 / total days owned) to calculate total taxable gain. This contradicts what I recall someone on here saying that if you lived in the rental for the last 5+ years then you get the full exclusion.

 

[joejetski]

Yep, the rentals gotta go someday. They have all appreciated a lot so I don't look forward to the taxes. We are toying with various ideas, like living in each one for a couple years to make it primary, then sell. Or do a 1031 exchange to buy a home where we want to live in the future, rent it out a couple years, then move into it.

My favorite plan exactly.

 

[surprising]

We got pretty close to selling one of our rentals. A long term renter moved out end of Nov. We did a month-long renovation and repair period, touched nearly every surface. We had it listed for all of December during the reno and got very little interest. I think the old dated photos didn't help. We took it off the market and finished up the reno. Once reno was done, we took new pictures, used AI for virtual staging, put it back on the market on New Years. Got 0 interest again for a week or so and started contemplating what to do. Lower price? Allow pets? Sell it? But luckily got a request to show it and they are moving in tomorrow.

 

[surprising]

Doing more research, I realized that I will qualify for 0% long term capital gains for a portion, if not all, of my taxable sales to fund expenses this year. Even with around $40K of ordinary dividends, I can have ~$80K of capital gains tax free. I don't anticipate needing anywhere near that much, so it would be nice to not pay any taxes on those gains.