Ron Ricard - Investment Property Exchange Services, Inc

Converting your Primary Residence into Rental Property
September 2, 2009 ·  

The tax code allows you to keep some or all of the gain on the sale of a primary residence if you meet certain conditions.  IRC §121 permits the exclusion of realized capital gain of $250,000 for a single person and $500,000 for a married couple upon the sale of a home that was their primary residence for any two years during the five years preceding the sale.  If your gain is in excess of this exclusion, you may have to pay capital gain tax on the amount over the exemption.  This exemption cannot be used more than once every two years.

 Let’s assume you have lived in your home as a primary residence more than two years, but decide to move out and turn the property into rental housing.  If you sell the property less than three years after you move out, you still qualify for that primary residence exemption of $250,000 or $500,000.  So if your gain (profit) is less than those thresholds, you will have no tax to pay on your gain, though you will have to pay depreciation recapture tax on the amount that you depreciated the property while it was a rental.  

But what if your gain is in excess of the exemption?  In 2005 the IRS issued Revenue Procedure 2005-14, which showed how you can combine the primary residence exemption with a 1031 exchange.  For example, you bought your house for $200,000 and it is now worth $900,000.  After living in it for many years, you convert your house into a rental property.  After renting the property for a couple years you have established the house as investment real estate, BUT you still meet the criteria of having lived in the property for two of the last five years.  When you sell it, it qualifies under both parts of the tax code.  That allows you to keep your exemption amount (either $250,000 or $500,000) in cash and do a 1031 exchange with the remainder. If you are married, you pocket $500,000 and exchange the remaining $400,000 towards another piece of investment real estate.  Note that the original basis goes into the exchange property, as you only get to keep the exemption tax-free.

 Lastly, if you do not sell the property in that three year window after you move out, your property no longer qualifies for the primary residence exemption and is now fully investment real estate.

  DISCLAIMER:  The information above is based on current tax code, which is subject to change. The above information should not be considered to be tax advice. You should discuss your personal situation with your qualified tax advisor.

 Ron Ricard

Investment Property Exchange Services, Inc

(877) 747-7875

ron.ricard@ipx1031.com

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Comments

5 Responses to “Converting your Primary Residence into Rental Property”

  1. Brian Boisson on September 3rd, 2009 8:54 am

    Ron,

    Ron, Thank you very much for your posting and welcome to PruCalVoices!

    You are always a wealth of great information and the facts you brought up are very useful to many homeowners who have owned for a long time and wish to move and stragegize their tax options available.

    I know I will be calling you when a potential seller asks me for creative ideas and bounce the situation off of you!

    Thanks a million!

    Brian Boisson

  2. Jonathan Shaw on September 3rd, 2009 9:32 am

    Ron,

    Thank you for sharing your valuable insight with us. It is always great to get expert information regarding the complex real estate market and the current law.

    Jonathan

  3. Shokoofeh Nowbakht on September 6th, 2009 10:02 pm

    Ron, Great information. Tax laws can be very complicated. I know who to call for clarification! :-)
    Thanks.
    Shokoofeh

  4. Larry Franzella on September 9th, 2009 3:14 pm

    Welcome to PruCalVoices – I know your blogs will be filled with information folks will be looking for.
    Larry Franzella

  5. Lee Ginsburg on September 13th, 2009 10:55 pm

    Ron,

    Isn’t there a new law that the property gets proportioned to time you owned it and time you rented it? I thought it began 2009.
    Great to see you joing us. We are looking forward to becoming “The Blog Site” for Bay Area real estate.
    lee

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