If rental is converted to owner occupied; then is $250K tax free?

Question

Consider I buy a property and rent it out. Then sometime in the future I occupy it as an owner for 2 years and then sell it off. Would I receive the full $250K profit from selling the property as tax-free money?

Chris Mason · Answer

Yup that's what all the CPAs say. $500k if married, $250k if single, 2 of the last 5 years, get tight w/ your CPA so you don't screw the pooch.

John D. · Answer

Thank you all for chiming in, especially for that example @Naseer Khan which helped clarify my doubts.

Naseer Khan · Answer

@John D. If you use the property as your primary residence for an aggregate period of 24 months in the past 5 years (does not need to be consecutive), you will qualify for the full capital gains exclusion ($250,000 single filer, $500,000 if married).

However, as a previous poster mentioned, the sum total of allowable depreciation deductions (whether you took them or not) while renting out the property will be taxed at 25%.

Example: You purchased a rental property in July 2005 and rented it for 3 years, taking $30,000 in depreciation deductions. In July 2008, you moved into the property, using it as your primary residence for the next 2 years, so you qualify for the IRC Sec. 121 capital gains exclusion. You sell the house in July 2010 and realize a gain of $80,000. Only $50,000 ($80,000 gain minus $30,000 depreciation deductions) of that gain may be excluded under section 121.  The $30,000 of unrecaptured depreciation will be taxed at 25% ($7,500). Accordingly, you will net $72,500 from the sale of the property ($80,000 gain minus $7,500 depreciation recapture tax).

Check out this article I wrote on IRC Sec. 121 Capital Gains Exclusion

And check out this article on Depreciation Recapture

This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

Dave Foster · Answer

@John D.  That quote is only for determining whether space that is part of your primary residence but not part of the living space such as a basement or garage apt. or a first floor office or retail with residence over (see their example) should count as residence or be excluded from the 121 calcs.

If that's true then you would want to take the residence portion as 121 and do a 1031 for the business portion.   523 gives specific instructions on what to do if those statements are all true or if one of them is not true.

Call up one of these accountants that have responded and offer to buy a 1/2 hour of their time.  It'll be money well spent.

John D. · Answer

If it is not acquired via sec 1031 exchange, what is the formula for calculating the exclusion? I'm confused case the IRS publication https://www.irs.gov/publications/p523/ar02.html#en_US_2015_publink10008937 states

"Determine whether the business or rental space still counts as a business space. A space formerly used for business is considered residence space if ALL of the following are true:

• You were not using the space for business or rental at the time you sold the property,
• You did not earn any business or rental income from the space in the year you sold your home, and
• You used the space as residence space for 2 years out of the 5 years leading up to the sale.

If all of these are true, your business usage does NOT affect your gain/loss calculations. "

Andrew S. · Answer

My understanding is that you will have to occupy for a full 5 years in order to re-gain the complete 121 exclusion

Brandon Hall · Answer

@John D. no, when you move into a previously rented property you will by benefit from the full section 121 exclusion. Instead, the excluded gain will be prorated. So some of the gain will still be subject to taxation.

Anna Buffkin · Answer

Consult your accountant, but generally, yes there are tax advantages. if you live in a property owner occupied for 2 of last 5 yr there are federal income tax exemptions on gains based on occupancy.

If rental is converted to owner occupied; then is $250K tax free?

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