Investor · East Syracuse, NY · Member since 2011 · 15 posts · 1 vote
Hi all. Want first to say how much I appreciate Bigger Pockets and the wonderful advice I have received here..
I own 3 rental properties at this point. My wife and I have lived in our personal residence for the past 15 years. I bought the house for $80000 and now it is worth about $170000. I have put probably $15000 into the house. I am the only one listed on the deed for the house.
As part of our plan to accumulate enough rental property to generate sufficient monthly cash flow to in order to retire (we also have other non real estate investments), we are planning on renting out our personal residence and moving into our next project property...This will allow us to keep the owner occupied financing that I have had in place on the house (I have checked my mortgage documents and I am in the clear to do this), intact and provide some nice cash flow that we can put to use in renovating our next project house.
I do not want to lose my one time capital gains tax exemption on my principal residence. In order to keep that, will I need to either sell that house within the next 3 years or move back into it again and live there for 2 years before I sell?
Any other advice/thoughts relating to this plan would be appreciated.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
14y
Dave T is on the money again. I'm starting to think he's trying to take my job. Consider selling now and purchasing another to exclude the current gain. You may be able to pay cash for a property or have two nice down-payments. You will also still qualify for owner-oc financing on one property.
Perfectly correct in that the exclusion can be used repeatedly in 24 month intervals and in some extreme cases sooner if certain factors apply.
Electrical Contractor · both, Maine & Florida · Member since 2011 · 129 posts · 53 votes
14y
You may be confusing todays rules with the old ONE TIME exclusion, today you can do it over and over. I believe the rule is, you must make it your primary residence for 2 of the last 5 years...
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Originally posted by Tom Wallace:
I do not want to lose my one time capital gains tax exemption on my principal residence. In order to keep that, will I need to either sell that house within the next 3 years or move back into it again and live there for 2 years before I sell?
The answer is YES. To be eligible for the capital gains exclusion, you have to have owned the property at least two of the five years prior to the sale, AND, you have to have occupied the property as your primary residence at least two of the five years prior to the sale. This means that you can vacate your primary residence after two years of occupancy, the use it as a rental for nearly three years prior to the sale and still remain eligible for the capital gains exclusion on the sale of a primary residence.
If you rent longer than three years, then you have to move back into the property and occupy as your primary residence for another two years to reestablish your eligibility to the capital gains exclusion.
As mentioned earlier, you can use the capital gains exclusion over and over again at 24 month intervals.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
14y
Dave T is on the money again. I'm starting to think he's trying to take my job. Consider selling now and purchasing another to exclude the current gain. You may be able to pay cash for a property or have two nice down-payments. You will also still qualify for owner-oc financing on one property.
Perfectly correct in that the exclusion can be used repeatedly in 24 month intervals and in some extreme cases sooner if certain factors apply.
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Originally posted by Steven Hamilton II:
Dave T is on the money again. I'm starting to think he's trying to take my job. -Steven the Tax Guy
Your guide to IRS laws, rules and regulations.
Steven,
I did not realize that contributing knowledge and expertise to the tax questions in this forum was your job. Sorry, if I stepped on your toes. It won't happen again.
Medford, MA · Member since 2012 · 163 posts · 36 votes
14y
The law was changed again in 2008 in a way that screwed people with rental property. You can't take an exclusion for the years it was a rental property from 2009 onwards. That is if you rented it starting Jan 1, 2013 until you sold it Dec 31st, 2014, you would have to pay capital gains tax on 2/18ths of the appreciation (assuming you've owned it for 18th years at that point). This proportion of the gain that you have to pay taxes on will increase every year. Of course hopefully the value will also increase.
Not sure why this is not widely known. Maybe Steven or others can speak more elegantly to the 2008 change.
Rental Property Investor · Colorado Springs, CO · Member since 2010 · 476 posts · 305 votes
14y
I've never done a 1031 exchange before, but if you do sell after the 5 years, can't he do a 1031 exchange??? Anybody who's done this feel free to comment as I don't know how the process works exactly.
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Monica,
In the scenario under discussion, the question concerns qualification for the capital gains exclusion on the sale of a primary residence. A primary residence is not eligible to participate in a 1031 exchange.
"Upon the sale of the property, the capital gains attributable to the non-qualified time period prior to conversion is no longer excludable. " Read article for more.
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
Paul - maybe I am misunderstanding something; so, let me review what I do know:
In my post above, I asked if you had any citations to support your statement. Please understand, as an attorney and as someone who works with tax matters, I always like to see authoritative sources before making any definitive conclusions. Thank you for the citations you provided. However, none of the cites are authoritative. By authoritative, I mean information that can be used to reasonably justify taking a certain position. I wouldn't expect anyone to cite case law, or even statutes, in a forum such as this. I realize I did not ask for authoritative cites; however, I would prefer to see official IRS documents for something like this. Cites to other forum posts or even articles carry no authority - but they do at least provide more information. In addition, anytime anyone starts talking tax law/implications, etc... there are lots of opinions (some accurate, some woefully inaccurate) I strongly recommend that anyone discussing a tax issue should refer to IRS documents or tax cases for justifying any position.
I also asked how this situation (meaning the situation Tom described in the original post) was different from the scenario I provided a link to: IRS Publication 523. The reason I asked is that I could see no difference between Tom's situation and the situation described in Pub 523. The situation described in Pub 523 specifically states the homeowner CAN exclude from income any capital gains from the sale of the home. However, maybe I misunderstood something, so it's always good to clarify. I did not see that question addressed in your subsequent posts.
The information you linked to describes how the law has changed to affect a situation different from Tom's situation.
As I understand Tom's situation - he bought the home, will then rent the home, then sell the home. Under this situation we look at the 5 years immediately before the sale. If Tom:
1) owns the property for at least 2 of those 5 years;
2) lives in the home as main home for at least 2 of those 5 years;
3) and there was no rental use of the home BEFORE Tom starting living in the home as main home (in the 5 year period)
He CAN exclude all capital gain (assuming other conditions met.)
HOWEVER, in the 5 year period before the sale of a home, if someone:
1) owns the property for at least 2 of the 5 years;
2) lives in the home as main home for at least 2 of the 5 years;
3) and there was rental use of the home BEFORE starting to use as main home (in the 5 year period)
He CANNOT exclude all capital gain (the portion of capital gain attributed to the rental period before being used as a main home must be included in income)
AGAIN See IRS Publication 523.
Please let me know if there is anything I misunderstood about this situation.
Investor · East Syracuse, NY · Member since 2011 · 15 posts · 1 vote
14y
Keith, fyi, you have described my situation accurately in your post above...
ie. I have lived in the home for the past 17 years. I have never rented the home out before. I plan to rent it out within the next 2 months. I plan to sell the home within the next 3 years...
Medford, MA · Member since 2012 · 163 posts · 36 votes
14y
The links I provided reference The Housing and Economic Recovery Act of 2008. Sorry I don't have time to read that but I appreciate your analysis of it.
It sounds like there are two main scenarios.
1) Buy a rental, rent it out for years, then move in for 2 years. In that scenario, you used to be able to exclude all the gain. You can't any longer.
2) Have a personal residence, convert to rental. This being the Tom Wallace's situation. It sounds like from your analysis you can still apply the 2 out of 5 rule as long as the rental period occurred after owner occupier period.
I was assuming the 2008 law disallowed all capital gain attributable to all rental periods. But it just disallows it for rental periods that occur before owner occupier periods. I guess the change was pretty terrible, but not as terrible as I thought. Thanks for correcting me.
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
No problem. I just wanted to make sure we were all on the same page. This stuff can be a pain in the butt to work with sometimes and it often takes reading through the IRS materials more than once to fully understand what the hell it means. I work with tax matters a lot (I managed a Liberty Tax Service office, I worked for Intuit as one of the Ask a Tax Expert agents supporting TurboTax users) and I still hate reading through the IRS stuff....
Real Estate Investor · Los Angeles · Member since 2011 · 55 posts · 11 votes
14y
If Tom Wallace is moving into his next project property, wouldn't that mean he is going to buy it? I think a 1031 would apply in that situation and because he would have a new primary residence that he owns, wouldn't that qualify him for the deduction? I think Dave T hit the nail on the head about the timing, but I'm not understanding why this new project property (if he's living in it) would not qualify him for the same capital gains extension in three years. Maybe I'm missing something. Taxes and law aren't my areas of expertise.
Residential Real Estate Agent · Long Beach, CA · Member since 2008 · 432 posts · 63 votes
14y
Tom, I'm wondering why you would consider selling at all if you are hoping for income throughout your retirement? Although Monica has a good idea IF you could get two rentals that generate more income with the proceeds of the sale of your home.
Paul & Keith--Thanks for the tax tip. I had not heard of that new rule. Bummer. I don't know that I really want to live in any of our rentals for 2 years before selling but it was in the back of my mind as an option. Now I don't have to think about it.
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
Mike - Tom doesn't need to even worry about a 1031 exchange in this situation since he qualifies for the capital gains exclusion in the circumstances he describes. I try to keep things as simple as possible (I don't always succeed), so there was no need to get into 1031 exchanges.
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Originally posted by Paul Morgan:
I was assuming the 2008 law disallowed all capital gain attributable to all rental periods. But it just disallows it for rental periods that occur before owner occupier periods.
I see it differently.
All periods of rental use that occurred after Dec 31, 2008 are periods of non-qualified use. Portions of capital gain attributed to periods of non-qualified use can not be excluded under Section 121.
Does not matter if the rental period occurred before or after use as primary residence. Any period of rental use in 2009 or later is excluded. Periods of rental use prior to Jan 1, 2009 are still periods of qualified use for Section 121 purposes.
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
Dave - You are correct: to a point. IRS Publication 523 states "Nonqualified use means any period in 2009or later where neither you nor you spouse... used the property as a main home, with certain exceptions....
A period of nonqualified use does not include:
1. Any portion of the 5-year period ending on the date of the sale... after the last date you... use the property as a main home...."
I hate the wording because it is challenging to slog through; however, if you take the time to figure out what the hell they are talking about we see that if you live in the home, stop using the home as your main home, then rent out the home, the rental period is NOT nonqualified use. It IS qualified use and the exclusion can be used (all other conditions being met....)
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
14y
Paul Morgan is quite correct that the HERA Act of 2008 modified IRS section 121. For tax years beginning 2009 and later any non-qualified use of a property is subject to capital gains on a prorated basis. If the home otherwise qualifies for section 121 treatment the taxpayer can exclude capital gains on the prorated portion used as a personal residence.
It is the exceptions as Keith Barton mentions that can be a little challenging to understand. Basically a taxpayer that uses their home as their primary residence and then converts it a rental can have this period exempted as long as they lived in the home two out of the last 5 years. Rental to primary does not fall under the exception.
Author J. Martin Burke writes: For purposes of IRC Sec. 121(b)(5), a period of nonqualified use means any period (other than the portion of any period preceding January 1, 2009) during which the property is not used by the taxpayer or the taxpayers spouse or former spouse as a principal residence. IRC Sec. 121(b)(5)(C)(ii)(I), however, creates a special rule whereby the term period of nonqualified use will not include any portion of the five-year period preceding the sale or exchange of a residence that is after the last date such property is used as the principal residence of the taxpayer or taxpayers spouse.
Example 2 in IRS Pub 523 under Business use or rental shows this exception and it sounds very similar to the one the OP is explaining.
Real Estate Investor · Lake Forest, IL · Member since 2012 · 10 posts · 3 votes
14y
In summary, the rule regarding non-qualifying use only apply to rental properties that were converted into primary residences, not vice versa. The scenario that best fit this is first occupying a property as a primary residence for 2+ years, converting it into a rental for 1-2 years, then sold within 5 years from start of the 2 years of primary residence for the full exemption under 121.
Now, the example given by IRS pub 523 clearly states that the 2 years within 5 does not have to be consecutive.
Now, then the question is whether or not a home has to be used as a primary residence for 2 full years before its conversion into a rental to take advantage of the exception under the new non-qualifying use rule.
Take this example: John buys a property to be used as his primary residence in January 2012 and live the for 6 month. He then moves out and use it as a rental for 18 months, during which time he does not claim any depreciation. He then converts it back to a primary residence and lives there for another 20 months before selling it for a total capital gain of $200,000.
John has within the 5 years period:
1. Used the property as a primary residence for 26 month (over 730 days required for the used test)
2. Owned the property for over 2 years (passed owned test)
3. Used the property as a rental AFTER first using it as a primary residence.
Does John qualify for the full exemption under 121?
Real Estate Investor · Gig Harbor, WA · Member since 2015 · 2 posts · 0 votes
10y
I hope it's ok to resurrect such an old thread.
I purchased my home in 1988. Converterted it to a rental in 2007. I intend to move back in next year, and sell it two years later in 2018. Do these circumstances mean I am an exception to the non qualified use rule? Meaning I may exclude $250k from any gain?
While the property started life as my primary residence, I'm a bit confused about the five year part of the exception.
Also, does the fact that my property was a rental on Jan 1 2008, have a negative implication for me, given that was the effective date of the new law.
Investor · Houston, TX · Member since 2015 · 7 posts · 3 votes
10y
@Tony Hayes §121 nonqualified use does not apply to the 5 year portion following the last date that the property is used as the principal residence of the taxpayer or taxpayer's spouse.
If you were to move back in to the home bought in 1988, in order to qualify for the §121 exemption, live in it for two years and then sell, the Regs stipulate that you would have 8 years of nonqualified use (the period it was a rental preceding the 5 year period following the last date that the property was used as your principal residence after Jan 1st 2009).
The use before Jan 1st 2009 is qualified.
You will have to pro-rate the nonqualified period for capital gains tax.
You might consider a §1031 exchange to defer the capital gains in addition to the §121 exemption.
Real Estate Investor · Gig Harbor, WA · Member since 2015 · 2 posts · 0 votes
10y
Michael, thanks for that clarification. I suppose if I moved back in for all of 2017 and 2018, I could turn the property into a rental again for 2019 2020 and sell before the end of 2021. In this way I could take advantage of the rule that was confusing me.
As I final data point I wish to state that The IRS applies years of non-qualified use to the capital gain realized at time of sale, not the $250k personal exclusion (for single folks). I was under the illusion that it was the personal exclusion that got reduced.