Living in rental and converting to condo regime

Accountant · Cincinnati OH 45245, USA · Member since 2022 · 112 posts · 112 votes

1y

1. I'm not too sure about a Captains tax, for that I would refer you to your local seaman :)

Kidding aside, yeah that's fine, assuming you meet the other requirements of Sec. 121 such as not having utilized the exclusion during the two-year period prior to the sale of the property in question, among others. Do note that you will still owe some tax in the form of depreciation recapture for the time that the property was used as a rental property. This amount should be fairly small though (low 4 figures if I had to guess).

2. I'll let someone else speak to the condo part as I'm unfamiliar with those specifically as it relates to Texas. For the tax side of things, the exclusion is available for the "home" meaning that if you sell one and keep the other, you'd have to sell the front lot - but the back lot could also be eligible for the exclusion even if they're sold on separate dates (potentially back lot sold first too), provided it meets a few additional criteria. You'd want to enlist the help of a CPA/EA who can help you plan it out since there's a lot more than the standard 121 exclusion involved if you go this route.

Regardless of your path forward, I encourage you to reach out to a tax professional who can assist and advise with your specific circumstance in order to make it more personalized to you. Also, IRS Publication 523 goes into more detail on this if you wanted some light reading material. :)

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Account Closed
OP
Member since 2023 · 17 posts · 3 votes
1y
Quote from @Benjamin Weinhart:

1. I'm not too sure about a Captains tax, for that I would refer you to your local seaman :)
Kidding aside, yeah that's fine, assuming you meet the other requirements of Sec. 121 such as not having utilized the exclusion during the two-year period prior to the sale of the property in question, among others. Do note that you will still owe some tax in the form of depreciation recapture for the time that the property was used as a rental property. This amount should be fairly small though (low 4 figures if I had to guess).
2. I'll let someone else speak to the condo part as I'm unfamiliar with those specifically as it relates to Texas. For the tax side of things, the exclusion is available for the "home" meaning that if you sell one and keep the other, you'd have to sell the front lot - but the back lot could also be eligible for the exclusion even if they're sold on separate dates (potentially back lot sold first too), provided it meets a few additional criteria. You'd want to enlist the help of a CPA/EA who can help you plan it out since there's a lot more than the standard 121 exclusion involved if you go this route.

Regardless of your path forward, I encourage you to reach out to a tax professional who can assist and advise with your specific circumstance in order to make it more personalized to you. Also, IRS Publication 523 goes into more detail on this if you wanted some light reading material. :
Thanks Michael. I think I rather stay home and sew my head to the carpet than read a IRS publication.
1. I don’t believe my tax bill for depreciation recap would be that high but who knows, every April 15th is like a bad birthday surprise.
2. The condo regime sounds like it could be a bit of a headache but if I could make a few more $$ it MIGHT be worth it.
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Michael PlaksPro Member

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

1y

Quote from @Account Closed:

1. I lived in it for 7 years, rented it for 3 years, now living back in it (to avoid capital gains tax if I sell). It is my primary residence but still in an LLC (owned by me solely)…. just don't want to pay to have it moved out. Please correct me if I'm wrong about assuming I'll have no captains tax on up to 250k profit/single bring that I'll be living in it as primary 2 out of 5 years.

So you lived there for 7 years, rented it for 3 years and then lived in it for another 2 years. This is a total of 12 years, 3 of which (25%) were renting. You can exclude 75% of your gain, not 100%. This comes from the sneaky "non-qualified use" rule that is often forgotten about, even by CPAs.

And depreciation recapture is an additional tax liability. Bottom line: you will reduce your taxes by moving back into your former home, but you will not wipe out your entire tax hit.

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Account Closed
OP
Member since 2023 · 17 posts · 3 votes
1y
Quote from @Michael Plaks:

Quote from @Account Closed:

1. I lived in it for 7 years, rented it for 3 years, now living back in it (to avoid capital gains tax if I sell). It is my primary residence but still in an LLC (owned by me solely)…. just don't want to pay to have it moved out. Please correct me if I'm wrong about assuming I'll have no captains tax on up to 250k profit/single bring that I'll be living in it as primary 2 out of 5 years.

So you lived there for 7 years, rented it for 3 years and then lived in it for another 2 years. This is a total of 12 years, 3 of which (25%) were renting. You can exclude 75% of your gain, not 100%. This comes from the sneaky "non-qualified use" rule that is often forgotten about, even by CPAs.

And depreciation recapture is an additional tax liability. Bottom line: you will reduce your taxes by moving back into your former home, but you will not wipe out your entire tax hit.

Wait, don’t I just consider the last 5 years which means I lived in it 2 of 5 years which means I qualify to not have to pay any cap gains (unless over 250k single)? I didn’t know there was a % calculation you either qualify or don’t qualify?
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Account Closed
OP
Member since 2023 · 17 posts · 3 votes
1y
Quote from @Account Closed:

Quote from @Michael Plaks:

Quote from @Account Closed:

1. I lived in it for 7 years, rented it for 3 years, now living back in it (to avoid capital gains tax if I sell). It is my primary residence but still in an LLC (owned by me solely)…. just don't want to pay to have it moved out. Please correct me if I'm wrong about assuming I'll have no captains tax on up to 250k profit/single bring that I'll be living in it as primary 2 out of 5 years.

So you lived there for 7 years, rented it for 3 years and then lived in it for another 2 years. This is a total of 12 years, 3 of which (25%) were renting. You can exclude 75% of your gain, not 100%. This comes from the sneaky "non-qualified use" rule that is often forgotten about, even by CPAs.

And depreciation recapture is an additional tax liability. Bottom line: you will reduce your taxes by moving back into your former home, but you will not wipe out your entire tax hit.

Wait, don’t I just consider the last 5 years which means I lived in it 2 of 5 years which means I qualify to not have to pay any cap gains (unless over 250k single)? I didn’t know there was a % calculation you either qualify or don’t qualify?
I will never forgive you for this Michael, I looked thru 523 and it seems your methodology is applicable if your property, at one time, is used as a rental and primary (like you leased on some land on you property, or a unit while living there). I’m not expert though. Here is what I found:

Space formerly used as business or rental.
Note that space formerly used as business or rental will qualify for exclusion under section 121 if the space was converted to the taxpayer’s principal residence for a total of 2 years or more, as long as the use as the principal residence was within the 5 years leading up to the sale. See Regulations section 1.121-1(a). However, depreciation deductions claimed during the previous business use must be reported on line 5a of Worksheet 2 and recognized as unrecaptured section 1250 gain. No separate Business worksheet is needed because there are no current business expenses. See Regulations section 1.121-1(d). See also the Instructions for Form 4797, and the Instructions for Schedule D (Form 1040).

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
1y
Quote from @Account Closed:
I will never forgive you for this Michael,

I'm not looking for forgiveness. And women never forgive anyway. ;)
If you prefer to disregard my professional advice, be my guest. But if you want to understand the concept of "non-qualified use" in the context of Section 121 exclusion, there's a mountain of information online, including this Bigger Pockets forum. You can search the forum for prior discussions of this tricky concepts. Yes, there IS pro-ration.
Also, if you convert your property to a multi-unit condo, you will lose the right to apply your exclusion to the parcels partitioned out. It does not mean that you should avoid it out of tax considerations. Business comes first, taxes a distant second or third.
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T. Alan CeshkerPro Member

Attorney · 3409 Executive Center Drive Ste 110 Austin, Texas 78731 · Member since 2020 · 99 posts · 92 votes

1y

Quote from @Account Closed:

Hello, I have a property in booming east Austin.

1. I lived in it for 7 years, rented it for 3 years, now living back in it (to avoid capital gains tax if I sell). It is my primary residence but still in an LLC (owned by me solely)…. just don't want to pay to have it moved out. Please correct me if I'm wrong about assuming I'll have no captains tax on up to 250k profit/single bring that I'll be living in it as primary 2 out of 5 years.

2. I’m thinking Austin just isn’t for me anymore. The lot is large with 3 new ~million dollar homes on each side and back. Condo regimes are popular here and I’m thinking maybe converting mine to a condo regime and sell either the back lot or the front lot with house and keep the other. How would this affect my capital gains taxes I’m trying to avoid? I’d be selling only part of the property (or both if it made financial sense). Any idea how much legal fees and headache having a condo regime set up would be?

My goal is to get the most $$.
TIA

I can only speak to the legal side vs tax.

The condo regime is easy to get in place and a very popular investment strategy. Not too expensive - a few thousand. But it greatly increases the total FMV of the property.

Message me and I can refer you to a very good attorney here -- I call her the condo queen

Thanks

Alan

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Account Closed
OP
Member since 2023 · 17 posts · 3 votes
1y
Quote from @T. Alan Ceshker:

Quote from @Account Closed:

Hello, I have a property in booming east Austin.
1. I lived in it for 7 years, rented it for 3 years, now living back in it (to avoid capital gains tax if I sell). It is my primary residence but still in an LLC (owned by me solely)…. just don't want to pay to have it moved out. Please correct me if I'm wrong about assuming I'll have no captains tax on up to 250k profit/single bring that I'll be living in it as primary 2 out of 5 years.

2. I’m thinking Austin just isn’t for me anymore. The lot is large with 3 new ~million dollar homes on each side and back. Condo regimes are popular here and I’m thinking maybe converting mine to a condo regime and sell either the back lot or the front lot with house and keep the other. How would this affect my capital gains taxes I’m trying to avoid? I’d be selling only part of the property (or both if it made financial sense). Any idea how much legal fees and headache having a condo regime set up would be?
My goal is to get the most $$.
TIA

I can only speak to the legal side vs tax.

The condo regime is easy to get in place and a very popular investment strategy. Not too expensive - a few thousand. But it greatly increases the total FMV of the property.

Message me and I can refer you to a very good attorney here -- I call her the condo queen

Thanks

Alan
Super! Who do you recommend? I have contacted one the other day but have been able to speak to her. TIA
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T. Alan CeshkerPro Member

Attorney · 3409 Executive Center Drive Ste 110 Austin, Texas 78731 · Member since 2020 · 99 posts · 92 votes

1y

Please send me a private message with your email and I can introduce you

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Account Closed
OP
Member since 2023 · 17 posts · 3 votes
1y
Quote from @T. Alan Ceshker:

Please send me a private message with your email and I can introduce you

No clue how to. You can leave their name here
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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

1y

A simplified version of how I would explain your situation.

1) if it was a rental first it’s always prorated taxes due. Buy a new property, rent it out for a year and then move in for 19 years as your primary. it’s 95% tax free (19/20ths) it doesn’t matter you passed the 2 of 5 years rule

2) if there’s any rental activity before the 5 year look back period, it’s pro-rated. You buy a new primary , live in it for 8 years. Then you rent it out for 2 years before moving back in to it for 10 years. That’s 90% tax exempt (18/20ths) because there’s rental activity before the 5 year look back period.

You’re only guaranteed 100% tax free (up to limits) if it’s your primary first and you sell before the 3 year anniversary of it not being your primary home.

If Micahel corrects anything I said, believe him, he’s an expert. I’m just trying to explain what I believe would occur in your situation. Your CPA should 100% agree with him.

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Michael PlaksPro Member

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

1y

@Bill B.

Nothing to correct, you got it.

Here is another way to say it:

1. If it has always been your primary, and you sell right away - full exclusion (up to the limit of $250k single or $500k couple)

2. If it has always been your primary, you have 3 years to rent it after you move out, and your full exclusion remains valid. The only gotcha is returning depreciation taken over those 3 years.

3. But if you move back - then you have to deal with pro-ration.

4. And if you missed your 3-year window after moving out, you're SOL.

*of course there're some conditions and exceptions for the above general rules

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Ashish AcharyaBusiness Member

CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes

1y

Since you've lived in the property for 2 out of the last 5 years, you may qualify for the $250K capital gains tax exclusion ($500K if married) under IRC Section 121 when selling. However, because the property is in an LLC, you may not be eligible for the exclusion unless you transfer it back to your personal name before selling. Check with a CPA or attorney to confirm if it's worth moving the title.

If you convert the property into a condo regime and sell only part of it, your tax situation gets more complex. The IRS may proportionally apply the capital gains exclusion based on the portion used as your primary residence versus investment. Selling the back lot separately (if never used as your residence) may not qualify for the exclusion and could be subject to capital gains tax.

Setting up a condo regime involves legal work, city approvals, and possible rezoning, which can cost $10K–$30K+ depending on Austin's requirements and surveyor/attorney fees. It’s a great way to maximize value, but you’ll want to weigh the costs and tax impact before moving forward. A real estate CPA and attorney can help structure the sale for the best outcome.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

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Living in rental and converting to condo regime

Living in rental and converting to condo regime

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