Capital Gains Exclusion with House Hack?

Question

Hi all,

I have a question about capital gains exclusion (living in property for 2 of the last 5 years). From what I understand, the exclusion is sort of pro-rated (e.g. if one owns a duplex and lives in one unit, then 50% of the gains would be excluded from taxes).

How would this work if one lived in a single family home, and house-hacked to have roommates during the time that the home was a primary residence? Does the exclusion then apply to the whole property, or to only part of the property? If it applies to part of the property, then how is that 'pro-rated' part determined?

Thank you!

Ashish Acharya · Answer

When are you trying to sell?

You are covered under normal  2 years out of 5 years test even if you will hold property until 2019.  Yes, qualified military can extend to 10 years.

So, looks like 2017 was the year you first rented it out. In your tax return for 2017, your rental income will be offset by the depreciation expense that you will claim. Your CPA will claim that for you

You will claim depreciation expense each year starting 2017 until you sell the house if the house is rented each year going forward. You have to claim the depreciation. IRS expects you to claim it. if you dont claim it, they will assume you did and you still have to recapture the depreciation that you never claimed. Once the house is rented, you start depreciation, not while it was a personal residence and not rented.

When you sell the house all the depreciation you claimed will be recaptured and will be taxed.

Lets say you sold the house after two years:

Sale price= 390k

Adjusted basis = 140k (160k reduced by 20k depreciation )

capital gain = 390-140 = 220

So, 20k out of 220k will be taxed at 25%. Rest of the gain is tax-free.

Hope that makes sense.

Honestly, your CPA is going to take care of this. Done sweat over it.

Nicholas Aiola · Answer

@Daniel Ortiz thanks for the shout out!

@Natalie Coleman

@Ashish Acharya hit the nail on the head - you can take the exclusion, but if you depreciated any part of the property, that will not qualify for the exclusion due to depreciation recapture.

Natalie C. · Answer

We don't have current plans to sell. Our tenants want to stay in the house for a few years and are extremely trustworthy, so we figure we'll let them continue to pay down our loan and let to property continue to cash flow for the time being.

Your explanation makes a lot of sense, thank you so much for taking to time to break down the numbers for me.

We don't yet have our own CPA. We recently moved and I used a local one last year for tax returns and he missed a bunch of things, so I've developed an attitude that 'I am my only advocate' a little more...

Natalie C. · Answer

@Daniel Ortiz @Ashish Acharya @Nicholas Aiola Thank you for the responses!

Just to be super clear - we lived in the property from about 2012-2016. Rented the spare rooms out to buddies while we were still living there. Have not yet reclaimed depreciation (mostly because we were not knowledgeable about it!). Currently the house is rented out on a formal lease to tenants.

We are military and therefore, as far as I understand, can extend the length of time that we can claim capital gains exclusion.

Now that we are no longer living in the property. I'll chat with a CPA soon, but it sounds like depreciation can never be claimed on the property if we want to exclude capital gains (property has gone from ~190k to ~360k), correct? Or could we just not recapture it during the time we were living on the property? Or are all of these questions just for a CPA that we need to hire??

Thank you all!!

Ashish Acharya · Answer

@Natalie Coleman ,

If the rental space was physically part of the living area of your home, such as a spare room used rental room, the rental usage doesn’t affect your gain/loss calculations and will qualify for the full exclusion given the you meet all other requirements, and looks like you do.

Keep in mind about the depreciation recapture tax on the rental portion of the house (even if yourdid not take it).

"Unrecaptured section 1250 recapture" taxed at 25%. This recapture is the Straight Line depreciation that you took on the rental portion of the property.

Natalie C. · Answer

@Casity Kao Thanks for your thoughts. Yep I definitely will seek advice from a CPA, just was hoping to feel out the real estate / tax minded folks on here to get an idea of what the rules say :)

Casity Kao · Answer

@Natalie Coleman  Should be 100% as you are residing in a single family home but you should have a trusted CPA to ask these questions.  A good CPA will provide more than enough value to pay for what they charge and if you are using TurboTax or another service you are probably missing deductions you don't know of.

Capital Gains Exclusion with House Hack?

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