Convert STR to primary to avoid depreciation recapture?

Question

Hey BP folks!

We have a few STRs that we have done cost segregation studies on. After operating the STR for the first year can we turn the STR into our primary residence for 2 years then sell and avoid capital gains tax and depreciation recapture instead of doing a 1031 exchange?

Dave Foster · Answer

@Tyler Speelman There's no issue if you want to convert your STR into your primary residence and live in it for those two years. you would qualify for a 121 exclusion which allows you to take the first $250k ($500k If married) of the gain tax free.

However, you won't get full exemption. The amount you will be eligible to get tax free is prorated on the number of years you've lived in the property as your primary residence.

What's even worse, when you sell the property you would still have to recapture any depreciation on the property, for the time it was held for investment. And if there is any of the gain leftover after the 121 exclusion, you would have to pay tax on the rest.

If you're looking to avoid a rather large tax hit, a 1031 is probably your best bet.

Andrew Strauss · Answer

Hi Tyler - you cannot avoid depreciation recapture if you convert STR into primary residence and then sell it. Capital gain can be avoided by using sec 121 home exclusion (upto certain limit).

Account Closed · Answer

Sadly this is not possible. But you can convert that STR into an LTR. Lots of gray area around that

Basit Siddiqi · Answer

There is no depreciation recapture if your are at an overall capital loss position.Something to consider when talking to your accountant.

Julio Gonzalez · Answer

If you are wanting to avoid depreciation recapture, your best option would be a 1031 exchange. Is that something you are considering?

Ashish Acharya · Answer

Converting your STR to a primary residence for 2 years can help avoid some capital gains taxes under the Section 121 exclusion (up to $250K or $500K if married), but it won't eliminate depreciation recapture. You'll still owe taxes on the depreciation taken during the time it was a rental, typically at a marginal tax for bonus dep recapture.  Even 1031 will not defer the bonus depreciation recapture on the segregated asset.

Sean Graham · Answer

You still have to pay depreciation recapture taxes.

You can continue to invest in real estate and create more depreciation losses via cost segregation to offset the recapture though.

Chris Seveney · Answer

@Tyler Speelman

Not an accountant

It’s my understanding you are just deferring taxes till you sell. I reviewed this with my cpa on an asset and was told basically when we do sell it and say we took $100k depreciation we would pay taxes on that money we took as depreciation. I cannot recall rate we pay - but essentially answer is you still pay.

Also the 250k/500k primary deduction is prorated as well depending on how long rental vs primary.

But as always speak to your accountant

Tyler Speelman · Answer

@Michael Plaks

Could I start a project as an investment property, take the depreciation in 2024 taxes, then recapture in 2025 taxes but plan to invest in RE that year to offset the recapture?

Convert STR to primary to avoid depreciation recapture?

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