home owner capital gain exclusion.

5 Replies

I have lived in my past primary residence for 13 years. 

I am considering renting it out for a small period of time, then selling.

What are the rules for doing this.

If I lived in it for 2 years, of the past 5 before the sale takes place, do I still qualify for the exclusion?

So effectively. I moved out of the home on 6/11/2018. I could rent the home out for 3 years, then sell and I would still qualify for the exclusion.

Is that correct, based on today's law?

Correct.  Your sales transaction must close in less than three years after you move out.  This is strict.  Miss it by a day and you lose the exclusion.

Originally posted by @Gabe G. :

I have lived in my past primary residence for 13 years. 

I am considering renting it out for a small period of time, then selling.

What are the rules for doing this.

If I lived in it for 2 years, of the past 5 before the sale takes place, do I still qualify for the exclusion?

So effectively. I moved out of the home on 6/11/2018. I could rent the home out for 3 years, then sell and I would still qualify for the exclusion.

Is that correct, based on today's law?

Here is a good article

https://www.fool.com/taxes/2017/12/22/your-guide-t...

@Gabe G.

Yes, it is correct. You have a 3-yr window to sell without capital gain taxes.

There will be a slight tax hit though: you will be taxed on all depreciation taken during the 3 years of renting. So, you will benefit from deducting depreciation for 3 years, but then you will have to return this temporary benefit when you sell - essentially a wash.

And, as @Jon Holdman said, the deadline is firm, cannot miss it even by one day.

And - very important - the rule assumes you do NOT move back. If you do, you may create some taxes, so keep it in mind.

@Gabe G. ,

Are you actually wanting to sell this house just so you can save taxes on your gains? 

If not, and you can actually want to get rid of the house, go ahead. 

If you want to keep the house And still not pay taxes on your appreciation. There are few ways to do it. 

1)  Do a 1031 exchange. After you rent it out for last few years, your house qualifies for like kind exchange.  You buy another better, bigger property, save taxes , and still get rental payments.

2) sell your existing house to your own S-corp. The residence can then be rented within the S corporation and depreciated at a stepped up value (purchase/selling price). Another benefit. The gain on the sale of the primary residence is also excluded, provided all the requirements under Sec 121 are met. I am sure we are taking about the significant appreciations  and benefit of tax saving outweighs the some of the downside of holding on S-corp. 

@Gabe G. I'll agree with @Ashish Acharya here: if you're wanting to sell the property primarily as a way to get some tax-free cash, then yes, sell within three years after moving and you qualify for the $250k(single)/$500k(married) Sec 121 exemption. Bear in mind that this applies only to capital gains tax, however, so you will still owe Sec 1250 depreciation recapture taxes for depreciation deductions taken while it's a rental.

However, if you're just trying to find a way to avoid taxes, generally, and don't necessarily need the cash, you have some other options. As Ashish said, you qualify for a 1031 exchange after holding your property as a rental for an extended period. There's no hard and fast rule, but the general consensus is that you're pretty safe from IRS scrutiny if you hold for at least 12-18 months. Then, you can use BOTH the 121 exemption AND the 1031 exchange -  taking some tax-free cash and then leapfrogging the remaining value into a new investment property.

For example, you move out now, you rent until 7/2020 (two years). Let's assume in 2020, when you're looking to sell, the house is worth $550k, but you only paid $250k and only have $100k left on the loan -  that's $300k of gain and $450k in equity. You still qualify for the Sec 121 exemption, so you could take all or most of the gain ($250k if you're single, all $300k if you're married) tax-free. 

Let's assume you only want $50k in cash. You can take it tax-free under Sec 121. The remaining value (500k, of which $400k is equity) can be used in a 1031 exchange to purchase a new investment property or properties (doesn't have to be 1-to-1). During your rental period, you would be claiming depreciation deductions on your taxes (don't skip it, the IRS considers any potential deductions as taken, regardless of whether you actually take them), but only for those two years. Regardless, the 1031 allows you to defer that tax as well, rolling the adjusted basis of this property into the basis of your replacement property. 

So after all is said and done you could: move out now, rent it for two years, sell it in 2020, pocket the amount of capital gain that you'd like to take as tax-free cash (up to the limits mentioned above), and then roll the remaining value in new investments. All taxes either exempted or deferred. 

With $500k in value and $400k in equity, you could easily leapfrog into a tidy little portfolio of cash flow properties in various markets in the South and Midwest. Even if you want the easiest, most hands-off turnkey option (so paying market prices, not deal hunting) you could set yourself up with a few thousand bucks in monthly passive income, and a handful to 10+ properties, depending on whether you leverage that equity to the hilt or pay cash for a few properties.

 Of course, if it turns out it's a great  rental and you don't need the cash, just hold it as a rental even longer, skip the 121 exemption and use the 1031 whenever you're ready to sell.

If it sounds complicated, it sort of is, and you must have a Qualified Intermediary on your team prior to selling your property in order for the 1031 to be valid, so the first step would be finding a trustworthy CPA and QI to make sure all your tax docs are in order. BUT, that being said, both these tax incentives are massively powerful tools for RE investors, and it pays to do your research and learn the ins and outs -  it could save you big $$$ when it comes to tax time.

Here are a couple helpful articles on the 1031 121 combo: 

https://www.1031exchange.com/converting-property/

http://www.exeter1031.com/article_overview_1031_12...

http://www.exeter1031.com/application_sections_103...

https://apiexchange.com/1031-exchange-primary-resi...

Either way you go, it sounds like you're in a good spot. Do your research and find some solid tax pros to help you get the most out of your property.

Best of luck!

Clayton