Pay capital gains tax after using my house as a rental?

Question

Hello BP community! I have owned my house for over 8 years now and it has appreciated a good amount. I know that if I were to sell it outright I WOULD NOT have to pay capital gains taxes on it. However.... I would like to rent it out and move into another property. I have heard that once you rent out a property if you were to sell it later you MUST pay capital gains taxes on it. Is this true?!? Please say it ain't so! Thanks in advance for all the help!

Joe

Natalie Kolodij · Answer

Hi Joe,

Since you've occupied the home for 2 of the last 5 years you qualify for the 121 exclusion.

This means that you can now rent the home for 3 years from the point you move out and you will still qualify, as you will have still occupied for 2/5 years.

However, there may still be depreciation recapture on the years it was rented/depreciated. This will be at your ordinary tax rate up to 25.

Dave Foster · Answer

@Joe Szymczak II, Account Closed hit on the other easy move. Once you turn that house into investment and are outside the exemption window but want to sell you can simply 1031 exchange it and buy another property or properties. The 1031 will allow you to defer both gain and depreciation recapture.

Account Closed · Answer

@Joe Szymczak II Moving out of your current residence and keeping it as a rental worked so well for me. In fact I've done it numerous times! At the end, I plan to do a 1031 Exchange to avoid paying capitals gains (or put it off for a very long time!) rolling several into a hands-off real estate investment (like a NNN Lease commercial property). If you haven't identified a property to move into, shoot me a message with your email or phone. I just came across a sweet deal on a Freddie Mac REO that can be purchase immediately as a primary residence. Great opportunity in a good neighborhood near Southpoint. Or, if it lasts, it will available to all (including investors at the beginning of August). Regardless, good luck with your home conversion!

Natalie Kolodij · Answer

The depreciation is not optional. It's allowed or allowable per the IRS meaning even if you don't take it...they'll tax you as though you did.

While that depreciation taken will increase the total gain- it will not create capital gain tax. The portion OF the gain that is attributable to depreciation is actually taxed at his ordinary incoem tax rate for the year (at a max of 25%)

Example:

Live in home 2 years

Rent home for 3 years - Took $10k depreciation over those 3 years

Sell home for $100k gain

$90,000 = $0 tax, primary residence exclsuion

$10,000= taxed at ordinary tax rates, up to 25%

Jon Holdman · Answer

If you rent you will need to take depreciation, and then there is tax on the unrecpatured depreciation in addition to capital gains. Depreciation reduces your basis, increasing your gain when you sell. And, don't think you can avoid this by not taking depreciation. The basis goes down and you pay the recapture tax whether you take the depreciation or not.

Natalie Kolodij · Answer

Hi Joseph,

Correct once you're outside of the 2/5 years it becomes taxable. There is a workaround but it's fairly complex. I'd chat with your tax professional to see what your options are.

Thanks!

Joe Szymczak II · Answer

Thank you very much for your input @Natalie Kolodij!

If I were to keep it rented out longer than 3 years (2/5 lived in) than I assume I would have to pay the capital gains tax at that point?

Joe

Pay capital gains tax after using my house as a rental?

Pay capital gains tax after using my house as a rental?

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