So BP community I need your help brainstorming a solution for a friend of mine. My friend lived in his previous home for three years, and moved out Nov 16th, 2014. He has been renting it out to one tenant for almost the past three years. The tenant living there offered to buy the home, but mortgage application just fell through due to bad credit. So, my understanding is he now has 20 days to sell the house if he wants to exclude the capital gain. (Only $8,000 of capital gain tax, so only a little meat on the bone to sale the home at a retail price to another investor.)
If your friend wants to use the two of five years rule to avoid the capital gains tax on the sale they must close the sale by Nov 15, 2017. No way around that. If they miss that, they will need to move back in and stay there for two years to be able to use this provision. Or they could move back in before that date and sell the property while living there. That way they have a period of less than three years when they did not occupy it and would have time before and after that period when they did to get the the two years.
Be aware that while they are renting the house the basis is going down by the amount of depreciation taken or allowed, whichever is greater. If they're not considering this, the gain will be higher than they think. Further, they will have to pay the tax on unrecaptured depreciation on the total amount of depreciation taken or allowed (again, which ever is greater.) Hopefully their accountant has explained how this all works.
They could sell by using some sort of owner financing that transfers equitable title. A lease option does not, but a wrap or subject to would. That has its own risk plus the risk of giving financing to a weak borrower.
Your friend could sell to his tenant on a contract for deed. As long as the contrct is executed before November 15, the §121 capital gains exclusion applies. Still have to pay tax on the unrecaptured depreciation.
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