What happens to expenses if I move into rental property?

5 Replies

I am buying a rental house with proceeds from the sale of a rental duplex.  I plan to renovate the house.  There is a possibility I will ultimately move into the rental and sell my current residence.  I know I would then have to pay the deferred taxes from the sale of the duplex but what happens to the expenses I took on the rental house during the renovation?  What do I need to do to still qualify for the tax deduction on the expenses?  Do I have to rent it for a certain period of time before I move in?  If so, what happens if I can't find renters and move in without having rented it?  

Thanks for your help!

Originally posted by @Jennifer Stanovich :

I am buying a rental house with proceeds from the sale of a rental duplex.  I plan to renovate the house.  There is a possibility I will ultimately move into the rental and sell my current residence.  I know I would then have to pay the deferred taxes from the sale of the duplex but what happens to the expenses I took on the rental house during the renovation?  What do I need to do to still qualify for the tax deduction on the expenses?  Do I have to rent it for a certain period of time before I move in?  If so, what happens if I can't find renters and move in without having rented it?  

Thanks for your help!

1) You have to pay taxes on the previous sale no matter you move it or rent out the new property. I am not sure if you knew that. Just buying another rental with the sale proceeds form sale of the previous rental will not defer tax even if you dont move in. You would have to do 1031 exchange if you wanted to defer the taxes.

2) No matter if you move in or occupy the house, all the work done before rental or before moving in will be added to the basis of the property. There is no deduction for that. The increased basis will decrease your gain when you eventually sell it or increase your depreciation amount if you rent it out. 

Thanks Ashish!  I should have stated I was going to do a 1031 exchange to defer the taxes from the sale of the duplex.  

I did not know the expenses incurred before the property is rented go into the basis.  On my duplex the expenses are taken against the rental income.  So is the difference in the way the expenses are handled based on whether the work is done before versus after renting it?  

@Jennifer Stanovich , Some clarifications.

1. Hopefully you have already started a 1031 and the QI was in place prior to the sale.  That would be a non-starter.  The way you phrased a couple of things made me wonder.  Your Qi must be in place prior to the closing of the sale.

2. Be careful that your intent in buying that new property is to hold for investment use.  It's ok to move in and change your intent at some point.  But you want to make sure that you can document your original intent to hold for investment.

3. When you move in it does not create a taxable event.  The tax remains deferred until you sell.  And if you reside in it long enough you will get at least a partial exemption of some of the proceeds tax free.

Thanks, Dave.  No transactions have happened yet.  We are selling our duplex to the property manager but have not started that process and we also could do a reverse 1031 if we bought the rental house before the duplex sold, as you advised me a previous thread:)

How do I show intent?  

Then if I successfully show intent, is there no affect on the way the expenses, which will be substantial, are handled on my tax return when I move in because the expenses were incurred while it was an investment property?   Do the expenses only go into the basis for depreciation as Ashish's post stated because the expenses are incurred before it is rented?  If the expenses are not affected, is it just how much tax I pay on the proceeds when I sell if I  change it from a rental to a residence?

I know I will need a more in-depth consultation with an accountant but just trying to evaluate the options and implications.

Thank you!

Jennifer

@Jennifer Stanovich , yep.  Just don't forget that in a reverse or straight 1031 the QI has to be in place prior to you taking title or giving up title.  

@Ashish Acharya is da CPA man!  Those expenses he rightfully says you can't take as expenses prior to putting the property into service become additions to basis.  Buy a property for 100K and spend 50K putting it into service and your basis is now $150K.  That will have an impact when and if you ever sell without a 1031.  It also gives you extra basis to depreciate.  So although you can't expense it current year you will get a benefit as you go.

Remember also no tax becomes due simply because you move into the property.  It is the sale that triggers tax.