Selling rental property
that was your primary residence is a common problem for ex-pats. For example, you
own a house in Omaha but have decided to move to San Miguel de Allende, Mexico.
When you get to Mexico, you fall in love with the city, the culture, the
people, the food, and the weather. Compared to Omaha, the winter never gets
much below freezing, and the summer never gets much above 90 degrees. You find
that the cost of living is about a third of the U.S., resulting in a decision
to live permanently in San Miguel and rent out the once primary residence in
Omaha.
Selling Rental Property That Was Your Primary Residence
Now, at some point
in the next five years, you face a dilemma. Before the conversion to a rental,
if you lived in the house for two of the last five years and sold the house for
a capital gain, you would exclude $250,000 each of the profit of $500,000. When
you convert from a primary residence to a rental, the clock starts over. You
can offset the rental income with depreciation, but you will lose the ability
to shelter the capital gains if you do not use the house for your primary
residence two years of the next five.
According to KLR,
Kahn, Litwin, Renza & Co, When you convert the property, you are eligible to
depreciate the tax basis of the building portion (not the land) over 27.5
years. Depreciation is a great way to offset rental income without actually
expending any additional cash.
KLR says, “It is important
to discuss your options with your tax advisor. The more facts and accurate
timeline you can provide, the more options you will have when weighing your
decision. This is certainly a situation where you don’t want to let the tax
tail wag the dog, but if you make one or two small changes to the
circumstances, you could net significant tax savings.
Selling Rental Property That Was Your Primary Residence
In my experience, I’ve seen
another example of selling rental property that was your primary
residence. A couple I knew would buy a house to flip. They would use the house
as their primary residence while they updated the house. They needed to live
there for at least two years. Then they would find another fixer-upper, move in
and rent the first house. Essentially, they lived in each house rent-free.
Ain’t real estate
grand?