Tax due to appreciation when renting out primary residence

2 Replies

Hi bigger pockets community. I've been living in my house for about 5 years and now plan to move to a different location. I plan to rent out the house i'm living in right now. I may hold it for a few years because location economy is in expansion.

There is about 100k appreciation in the past 5 years and I know I don't have to pay for the tax if I sell the house now. However, I learned that if I convert this one to rental house, the cost basis has to be the purchase price instead of the market price at this moment. which means if I convert the house this year and sell it in a few years, the 100k appreciation happened when I was using it as primary residence is taxable. 1031 is an option but what if I need the sales proceeds for other purpose? Does 2 out of 5 years rule apply here? in other words if I sell in 3 years all the appreciation since 5 years ago are not taxable?

I appreciate any suggestions. Thank you very much.

@Sheen Jowl

You are thinking in the right direction. Let me clarify a few things

-  If you sell now or after 3 years of moving out, you dont have to pay any taxes on the appreciation. 

-  Even if convert it to a rental now when you move out and sell within 3 years of moving out,  you still dont pay taxes on the appreciation ( because of the 2 out of last 5-year rule) 

-you will only pay taxes on the depreciation you have taken while renting out. 

- Also, remember you can do 1031( within three year of moving out)  in a way that you receive required cash and still defer other remaining gain. The cash you received in 1031 would still be nontaxable under sec 121 ( 2 out 5 rule) 

Also, if you think the cash flow in this house makes sense, dont sell it to tap into the appreciation. You can get a HELOC loan or refinance the house. It is hard to find a house that is already cash flowing, I would keep the house and think of other ways of tapping into the equity of the house.

@Sheen Jowl , You can get both as long as you sell within 3 years of moving out.  If you do that you can 1031 because you are selling an investment property.  You also still qualify for the 2/5 primary residence exemption.  It's the best of both worlds.!!  Go beyond the three years of rental and you would no longer qualify for the primary residence exemption but could still 1031.  And if you need cash, do a refi of the new property.

Using the basis of purchase price when you set it up as a rental is only a disadvantage in that it lessens your annual depreciation allowance.  You have so many options available to you in the future I'd simply take a look at today.  If it makes sense to hold then hold.  You've got plenty of runway in front of you.