Possible to avoid Capital Gains Tax by moving into property?

Question

In regards to the IRS rule(s) that allow single/married individuals to realize a tax free gain on real property sales up to $250k/$500k so long as they live in the property for 2 of the past 5 years, is it possible for an investor to buy a house, rent it out to tenants for many years, turn around and move in to the house, live there for 2 years, and then sell it and avoid paying the capital gains on it?

Dave Foster · Answer

Account Closed speaks of is gold!  I tell my story at www.the1031 investor.com of turning real estate in three markets into a sailboat we cruised in for 10 years using this exact strategy.  Disclaimer - this was pre 2008 when the IRS finally caught up with things.  Prior to that we could do exactly what you suggested.  But rent, convert, live for 2 and get rid of all the gain.

The new rules are exactly what Ashish described.  But... Using the combination you can prepare for retirement by lining up your retirement villas using 1031 and then moving into them in order and living in each for a while.  You won't get 100% tax free.  But you will get some tax free and pay some tax while you move into  the next one.  I have several clients planning this exact way.  As a retirement job it beats sacking groceries or delivering pizzas for sure.

Ashish Acharya · Answer

This works just to shield a portion of the gain. If total ownership is 10 years( first 8 years rental, last two years PR),  excluding depreciation recapture, only 20% of gain is shielded.

There are other ways to defer gains- 1031 exchange, investing in new opportunities zones, and so forth.

The best strategy is to combine section 121 and other deferred methods like 1031.

You can completely avoid taxes on the sec 121 eligible gain (20% as mentioned above) and defer the rest.

Ashish Acharya · Answer

Account Closed,

What do you think ? If there is a hack like that, IRS already has a remedy.

There is something called non qualified use.

So you have to prorate your gain between taxable and non taxable gain.

There’s is no non qualified use if you buy a house, live in it for 2 years, and rent it out for 3 years, in that order.

Account Closed · Answer

@Ashish Acharya Thank you for your explanation. I suspected, as you hinted to, that there likely was a way the IRS would prevent this from happening.

The only way I could see a beneficial scenario play out in real life would be if a person were to buy a primary residence in an area, at a low price at the right time (San Francisco 2010?), move out and rent it for several years while it appreciated dramatically, only to move back in and live there for 2 years before selling it. Am I on the right track? Of course I'm confident there are a few other wrenches that should be thrown in there (i.e. Depreciation Recapture).

Also, this is merely a question in theory as I have no intent in executing a strategy like this. I am simply trying to better understand how the IRS would approach this situation.

Thanks again for your input!

Brandon Hall · Answer

As previous posters mentioned, it won’t work the way you are hoping it will.

But you should absolutely explore liquidating and investing the gain proceeds into an opportunity fund (new for 2018). Best tax break in decades.

Ashish Acharya · Answer

There is always going’s to be depreciation recapture no matter when you rent it, before or after you live it the house.

I was more explaining about the non qualified periods.

The depreciation recapture is talked so much on this forum, now a days I wrongly assume everyone is aware of it. My mistake.

Carl Fischer · Answer

@Ashish Acharya

Don’t you also have to pay depreciation  recapture tax?

Possible to avoid Capital Gains Tax by moving into property?

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