Would AirBnB jeopardize my capital gains tax exemption?

Question

Im currently 6 months into a live in flip and Im having trouble making the mortgage payments on the home with my income alone. We get a bit of tourism in Bend Oregon and Im in a nice part of town across from a big park, so I think there may be a good opportunity to do vacation rentals. Although the CC&Rs of the neighborhood prohibit short term rentals, there is an exemption for renting out individual rooms. So, I am considering converting my guest bedroom to an AirBnB with the guests sharing my personal living room and kitchen.

My concern is that if I rent out the guest bedroom then I wont be able to claim the homeowners capitol gains exemption when I sell in approximately 18 months. I imagine that I may only get a partial exemption similar to if I were living in half of a duplex, is this the case? Any advice would be appreciated, thank you for taking the time to help!

Natalie Kolodij · Answer

@Grayson Graham

I grew up in Bend! Small world.

If you AIR bnb part of your property it will turn that % to business use. You are correct- it will be much like if you rented 1/2 of a duplex.

It will reduce the amount of your primary exemption you get to utilize- HOWEVER. You can do a 121/ 1031 combined sale.

Meaning if 50% of your property ends up being a rental and 50% stays your primary. You can sell the property....your 1/2 will be tax free via the 121 primary exemption...and if you buy a new rental you can roll the gain from the business 1/2 into that via a 1031 exchange and not pay any tax there.

@Dave Foster Is a great resource for 1031 questions.

Karen Margrave · Answer

Actually, it's Account Closed that is the expert on 1031's.

Josh Garner · Answer

Another strategy could be to do a cash-out refi in 18 months instead of selling (I'm assuming you'd like to re-deploy your capital somewhere else). You could still take advantage of a partial exemption on capital gains (if you eventually sold it), assuming it was your primary residence for 2 of the previous 5 years.

If you had a rental agreement in place at the time of cash-out refi, you could count a good chunk of that rental income towards your monthly income to qualify for the new loan (percentages vary based on loan type, but are generally 75%).

This is the strategy I pursued, and I essentially "sold" my former primary residence to myself via cash-out refi, then bought another home here in Bend. I'm coming up on the end of my 2-out-of-5-years time period, and am selling to avoid major capital gains, but with this strategy I was able to hold on to the property for an extra 3 years, netting me lots of appreciation.

A good CPA will provide some more clarity on your specific scenario.

Karen Margrave · Answer

@Grayson Graham you probably need to go talk to a CPA. I did a search on BP to see if there are any from Bend, but I didn't find anyone that has posted recently. Good luck!

Paul Sandhu · Answer

I'm going to take a SWAG (scientific wild azz guess) and say that it will jeopardize your tax exemption but the profits you make on Airbnb will more than offset the tax exemption.  But that's just my SWAG.

Dave Foster · Answer

@Susan O.The math works on that.  But there may be a gotcha.  The first unit is no problem.  Live in it for 2 and then convert it to a rental and move out.  You now have 3 years to sell it and still be able to claim you lived in it for 2 out of the 5 years before sale.

But when you move into the other unit you are converting a rental to your primary.  That is a different conversion and I think you'll only get to prorate the gain from that one between the time you used it for investment and rental. @Natalie Kolodij.  What say you?

Dave Foster · Answer

Thanks @Natalie Kolodij for the shout out.  I know you'll have fun with this one.  @Grayson Graham, there is some really fascinating discussion on this subject in topic 415 from the irs - https://www.irs.gov/taxtopics/tc415.   It'll depend on where you and your accountant fall but here's a couple of thoughts.

1. Typically rentals with shared common area and part of the residence (like just a bedroom) do not jeopardize your exemption although you do have to declare the income.

2. In my mind it's murky when you try to reconcile this with something like a carve out for your home office.  But my thought would be that this would be considered a separate situation.  But if you did carve out that bedroom and tried to depreciate it and take expenses then you would lose your exemption on that portion.

3. There's even a provision (I had missed it before) where you can even exempt declaring the rent if it is just part of your residence and you rent it for less than 15 days a year.  In an Air BNB situation that might come into play.

4. This situation is different from a duplex because you're dealing with shared living spaces.

Account Closedmight have some good words for you as well.

Grayson Graham · Answer

Bigger Pockets is amazing! Thanks everyone for the feedback, iv learned a lot from the discussion. I am going to pursue the AirBnB rout now that I am more confident that it wont totally mess up my live in flip.

Josh Garner · Answer

@Karen Margrave is a great resource for 1031 questions as well, and is here in our local market. She gave a great presentation on 1031's at our meet up a few months ago.

Not sure if it's helpful, but anything over 30 days is not considered short-term in Bend. Airbnb has plenty of listings with a 30-day minimum, due to owners not having a short-term rental city permit. Space is at a premium around here, and I don't imagine you'd have too much issue finding suitable visitors interested in whatever space/timeframe you were offering.

Karen Margrave · Answer

You might try posting under forum for Financial, Tax & Legal.

Would AirBnB jeopardize my capital gains tax exemption?

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