Avoiding capital gains by occupying your California rental

Corona, CA · Member since 2018 · 4 posts · 1 vote

We have owned a home for over 8 Years and rented it for the last six years in California. Can we occupy for the next two years and then sell as owner-occupied to avoid capital gains?

1 Reply

36 views

Most Popular Reply

Ashish AcharyaBusiness Member

CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes

Originally posted by @Elena Mafla:

We have owned a home for over 8 Years and rented it for the last six years in California. Can we occupy for the next two years and then sell as owner-occupied to avoid capital gains?

No you cannot. If you move back in and live it in for two years, then you have to prorate the gain into excludable and includeable gain.

Not entire gain can be excluded. This is called nonqualified use of the personal residence. You don’t get to to exclude the appreciation when the property was rented if you move back in And convert this to a personal residence.

You will also have to pay a maximum 25% tax on the depreciation you have claimed so far.

So basically, if you move back in, and then sell the house after two years ,you will have three components

1)taxable gain

2)depreciation recapture taxed at max 25%

3) excludable gain( 20% of gain if you sell it in two years)

[email protected]941-914-7779

INVESTOR FRIENDLY CPA®5240 Reviews

Website View Page

TaxMD® | Tax Planning Software

Website View Page

2 Reply

See this reply in the discussion

8 Replies

Jump to latestLatest

Sort by

Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
7y
Originally posted by @Elena Mafla:
We have owned a home for over 8 Years and rented it for the last six years in California. Can we occupy for the next two years and then sell as owner-occupied to avoid capital gains?
No you cannot. If you move back in and live it in for two years, then you have to prorate the gain into excludable and includeable gain.
Not entire gain can be excluded. This is called nonqualified use of the personal residence. You don’t get to to exclude the appreciation when the property was rented if you move back in And convert this to a personal residence.
You will also have to pay a maximum 25% tax on the depreciation you have claimed so far.
So basically, if you move back in, and then sell the house after two years ,you will have three components
1)taxable gain
2)depreciation recapture taxed at max 25%
3) excludable gain( 20% of gain if you sell it in two years)
[email protected]941-914-7779
INVESTOR FRIENDLY CPA®5240 Reviews
Website View Page
TaxMD® | Tax Planning Software
Website View Page
2 Reply
Lance LvovskyPro Member
Accountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
7y
@Elena Mafla
You will have to recognize some of the gain. Depreciation recapture. Have your CPA calc it.
1 Reply
Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
7y
Originally posted by @Lance Lvovsky:

@Elena Mafla
You will have to recognize some of the gain. Depreciation recapture. Have your CPA calc it.
what if you did not rent the other house ??? and you never depreciate it. ?? how would that work.
Podcast Guest on Show #222
JLH Capital Partners51 Review
Website View Page
0 Reply
Bryan ZuetelPro Member
Attorney · Orange County, CA · Member since 2017 · 242 posts · 99 votes
7y
@Elena Mafla, run the numbers, but I suspect that if you purchased the property in Corona 8 years ago and have properly treated it as an investment property for the last 8 years, you have significant appreciation and capital gains. You would likely be better off selling the property and doing a 1031 tax-deferred exchange, rather than trying to move back into the property and trying to exclude a proportion of the gains under the personal residence exclusion.
2 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Jay Hinrichs, that's a great question and one to press the service on. The new rules circa 2008 surrounding conversion of rental to primary were to allow the govt to still get part of the gain from a property used for productive investment use. They have also made a great distinction between property held for productive use vs property held primarily for personal use (like 2nd homes and vacation homes). In cases 1031 exchanges have been disallowed because the primary use was deemed to be personal rather than investment.
So couple those two elements together for you and you've got a great argument that the other house was not an investment property because it was not rented and it was not depreciated and your intent was not to hold if for productive use or you would have rented it and depreciated. What that house was in reality was a personal (not primary) residence. And you should indeed be able to move into it (not convert it simply move into it). And when you have lived in it for 2 out of the previous 5 years get the entire primary residence exclusion.
There's very little case law here. @Ashish Acharya and @Lance Lvovsky what's your take on this?
The 1031 Investor5137 Reviews
Website View Page
1 Reply
Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
7y
Originally posted by @Dave Foster:

@Jay Hinrichs, that's a great question and one to press the service on. The new rules circa 2008 surrounding conversion of rental to primary were to allow the govt to still get part of the gain from a property used for productive investment use. They have also made a great distinction between property held for productive use vs property held primarily for personal use (like 2nd homes and vacation homes). In cases 1031 exchanges have been disallowed because the primary use was deemed to be personal rather than investment.
So couple those two elements together for you and you've got a great argument that the other house was not an investment property because it was not rented and it was not depreciated and your intent was not to hold if for productive use or you would have rented it and depreciated. What that house was in reality was a personal (not primary) residence. And you should indeed be able to move into it (not convert it simply move into it). And when you have lived in it for 2 out of the previous 5 years get the entire primary residence exclusion.
There's very little case law here. @Ashish Acharya and @Lance Lvovsky what's your take on this?
Dave,
The nonqualified use applies to vacation home(second home) as well. The second home does not necessarily have to be rented. The renting will just bring the depreciation in the picture, but the ownership is still non qualified.
If you think about it, the second residence never qualified for sec 121 anyway. So, moving back in last two year would not convert the unqualified years before to qualified period.
If the house was not a primary residence, the period of the time it was held as the second home is non-qualified,
[email protected]941-914-7779
INVESTOR FRIENDLY CPA®5240 Reviews
Website View Page
TaxMD® | Tax Planning Software
Website View Page
1 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Ashish Acharya you're absolutely right about that second property never qualifying for 121. But it also would not qualify for 1031 as productive investment property which made me wonder if the ownership period of a true second home wouldn't magically fall into never never land :) Yah, sec 121 (b) is tripping me up. Trying to find a "sauce for the goose...sauce for the gander" thing with IRS regs. You ruined my Sunday :)
The 1031 Investor5137 Reviews
Website View Page
1 Reply
Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
7y
Originally posted by @Dave Foster:

@Ashish Acharya you're absolutely right about that second property never qualifying for 121. But it also would not qualify for 1031 as productive investment property which made me wonder if the ownership period of a true second home wouldn't magically fall into never never land :) Yah, sec 121 (b) is tripping me up. Trying to find a "sauce for the goose...sauce for the gander" thing with IRS regs. You ruined my Sunday :)
Haha. Sorry.
[email protected]941-914-7779
INVESTOR FRIENDLY CPA®5240 Reviews
Website View Page
TaxMD® | Tax Planning Software
Website View Page
1 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.