Homeowner exclusion or Split 1031 on a SFH with a tenant/roomate?

Question

I'm curious how I would treat gains if I sell my primary residence taking into the account that I rent part the house out.  Additionally, I'm wondering if there's anything differently I should be doing now for taxes.

Single Family Home with a fully finished basement.

A friend rents the basement from us. Essentially a roommate/tenant.

All utilities are combined (we pay all utilities).

We claim the $1000/month rent as income.

We claim 50% of utilities as expenses for a tax deductions. (Based on square footage)

We depreciate 50% of the property as a rental based on square footage. (I'm considering changing this to 33% of the property based on rental value instead of square footage, as the upstairs would rent for 2x the downstairs)

How would I tax capital gains in the event of a sale? By the time I complete renovations, I'll have about 250k in equity? I've heard some people say just take the home owner exclusion, back out depreciation, and be done with it. (I'll meet the 2/5 year rule).

Others have said do a split 1031 on the part I rented out, but take the home owner exclusion on the rest. That's one of the reasons I want to only depreciate 33% of it going forward, to only claim 1/3 of the property as a rental.

Another big question; what would "Like Kind" look like for a  split 1031 on SFH? Could I buy another SFH with all the money and intend on renting out a room again?

Derek Daun · Answer

Oh, I forgot to add my wife works 100% from home, so there's that 10% of home upstairs depreciated as well!

Dave Foster · Answer

@Derek Daun A unique situation for sure. The answer is easy if you were dealing with two separate property identities or if you were dealing with the same property that you had changed use on.  But you're talking about one identified residence parcel that you use part for residence and part for investment.  I don't know if I would go the route of claiming that all as primary residence.  You've built up a pretty solid picture for one portion only being primary residence and the other being investment.  Likewise, I don't know if it's advisable to change your depreciation table at this point.   You've treated it as two separate probably better to continue that with the paper trail you've built.

But that being said, you are right you could take at least 50% of the gain tax free and 1031 the other 50%.

Regarding like kind you'll need to purchase investment real estate for investment real estate with the 1031 proceeds.  So if you sold the property for 400K 50% of that would go into the 1031 so you would need to purchase at least 200K of investment real estate.  You could purchase a 400K duplex and live in 50% of it.  But I think you'd be asking for trouble to buy another primary residence that you planned to house hack part of once again.  You'd have to at least make sure the the portion you rented out was worth at least 200K since that's the size of your 1031.  Now you're once again dealing with allocations of one unit into residence and business use.  And we know how much the IRS loves home offices!

There's an argument to be made but it's a very agressive one.