Rental Property Turned Primary Residence
Hi guys,
had a newbie question for you guys on taxes. I'm located in California. I just moved from my primary residence (kept it and now it's a rental property) and bought another condo. After two years I will move back into the rental property (selling the condo I'm currently at). I will live there for two years and more than likely sell at that point (possibly a 1031 exchange?).
My question is what actions (in terms of taxes) should I be doing now that it is a rental property. Should I or do I have to depreciate? If so, what happens when it becomes my primary residence? Will there still be a recapture on it? Anyway to avoid it? I've read some material on it, but it's confusing to me and it doesn't talk about my particular situation. And in terms of selling when I eventually do want to sell the rental unit, what should I do?
Just some numbers so I can understand better:
Bought at: $225K
Mortgage left to pay: $125K
Can sell for (at this moment): $425K
Thanks in advance for your help -- I appreciate it.
Avi
It is a very good technique to 1031 properties and then eventually live in the last one for 2 years and take the whole gain tax free!
If I understand you correctly you want to move into a rental property and then sell it 2 years later. YES, this gain is tax free. During this time it is your choice to take deprecation or not but you might as well take it for the tax benefits! You don't pay recapture tax or anything. The WHOLE gain is tax free
Now you also mentioned that you origionally lived in this property. If you lived in the property for lets say 1 year and then you rented it for up to 3 years, you can move back in it for only 1 year and take the gain tax free! The test is that you must have lived in the property for 2 of the last 5 years.
I don't know for sure but you could probably simply live in your current proprety for 2 years, rent it out for 3, then sell tax free at the end!
This information came from Starker Exchange. I am not an attorney or accountant. You should always consult competent professionals.
Lenders typically view second homes as a higher risk, you may pay a slightly higher interest rate, see higher fees and be required to hand over a larger down payment, Many lenders require 20 percent or more down.
The interest you pay on your second home's mortgage is tax deductible, assuming you don't rent it out for more than two weeks a year. But, any profit you make on the property is subject to capital gains, unless of course you eventually sell your primary residence, move into your second home and live there for at least two years
A related law also makes provisions for you if you are forced to sell before you meet the two-year residency requirement due to an unforeseen event (such as illness or a job change). Called the federal Internal Revenue Service Restructuring and Reform Act of 1998, it says you can prorate $250,000-$500,000.
That means if you only live in your home a year before you are forced to sell, you can get a tax break of up to $250,000 in capital gains if you are married and filing jointly, or one of up to $125,000 for separately filing spouses and singles.
That means if you only live in your home a year before you are forced to sell, you can get a tax break of up to $250,000 in capital gains if you are married and filing jointly, or one of up to $125,000 for separately filing spouses and singles.
The relief act has also removed the $125,000 tax exclusion on capital gains that homeowners older than 55 used to receive. It also removed the "rollover" law that allowed you to defer paying your taxes, provided you purchased another, more expensive home. (You must pay any deferred taxes created before the tax relief act.)
You really should talk to your tax professional. My account directs me to take as capital gains, regular income, when to do a 1031, when to buy for profit or when to buy for a loss too off set taxes.
So, all that I depreciated goes bye-bye? That's basically free money (if a person returns back to their rented property for two years). Why aren't more people doing this if that's the case? Or are they?
And technically, I can do the same for the residence I am currently at? Move back into the rental property, make the other property a rental property. depreciate that for two years and sell both two years down the line without captial gains?
That sounds too good to be true so it probably is...
thanks for posting, very interesting topic
A lot of people do this! The only problem, as I see it, is that most landlords live in a home nicer than their rentals. Most people also don't want to down--only up to nicer places. My goal is to maybe pick up an expensive sub2 property that my buyer backs out on and I decide to move into it. If it works, great, if not oh well. No one ever went broke paying taxes!
Well, this was my first and second condo and aside from upgrading to a 2 bedroom condo this time, the one bedroom condo (now rental unit) is a really great condo and I wouldn't mind moving back into it. The problem in Caliofrnia is that rental properties aren't worth it anymore. The rent would never cover PITI -- not by a long shot. Luckily, I got in when the time was right, but this'll be the end of my run.
This seems to be a great method to do if you buy livable places and are willing to move around every two years. Keep buying rental properties, depreciating them, moving into them, and selling after two years. Interesting concept. Any financial negatives with this? I'm interested to hear them (or pros for that matter).
Thanks,
Avi
Sorry, depreciation is not optional. Even if you fail to claim depreciation, your basis in the property (which eventually determines your gain) is still decreased by the amount of depreciation you should have taken. Even if you convert to a principle residence and later sell, you still need to recognize previously deducted depreciation. For example, if you took 5,000/yr in depreciation, your basis would be reduced to $215. If it qualified as a personal residence and you sold it for $240, you would recognize $10 in gain (the depreciation taken) and the other $15 would be excluded. Also, if you're using it as a principle residence at the time of sale, it would be ineligible for a 1031. Still looks like it's worth it to convert to your residence to exclude most of the gain. As always, talk to a good CPA.
A couple of follow-up comments.
Depreciation is not optional. If it is rental property you must depreciate.
If you have rental property and have depreciated it, and then convert it to your primary residence, you can exclude the capital gain up to $250K if you are single and up to $500K if you are married, BUT you will get hit with depreciation recapture.
In your example, if you live in the first property as your primary residence, convert to rental property when you buy the condo, and then convert it back to your primary residence when you sell the condo you would not be eligible for 1031 exchange treatment because the last/current use is not rental/investment/business property. The better approach would be to make sure that you have lived in that property for at least 24 months out of the last 60 months and then sell and take advantage of the 121 exclusion.
Bill.
[addsig]