Selling rental - capital gains

[Brad Rondeau]

Hello, I bought a condo in Laguna Niguel CA in December 2009 (short sale) for $365,000. Today it is worth about $550,000. In 2009/2010 I did $29,852 of improvements including interior paint, carpet, remodel kitchen/bathroom, new AC/Furnace. I lived in the condo for about a year and then rented it out for the next 8+ years. Renters just gave notice and now  I want to sell it but I’m thinking I need to move back in for a while, so I don’t get killed with taxes on the gain. I need to do new interior paint and baseboards and carpet for about $7000. So –

Paid 365,000

2009 Improvements 29,852

2019 Improvements 7,000 (estimated)

Expected commission upon sale 33,000

Cost Basis? 434,852

550,000 – 434,852 = 115,148 (I believe this is my capital gain). I’m retired now living off savings. The year that I sell the house my income will be the 115,148 plus maybe 20,000 in interest/dividends/stock gains. Would it be 20% federal capital gains tax for the sale of the condo? I will be single when the house sells and believe I can have a gain of $250,000 without paying taxes as long as it is my primary residence for the 2 years before I sell it. Here is my question. If I live in it for only one year and then sell it – would 125,000 be tax free (this is what I read somewhere – that if you live in it for a percentage of the 2 years then you get that percentage of the 250,000). I really don’t want to live in it for 2 years so 1 year would be much better as long as I can keep from paying any capital gains tax. Also does CA work the same as federal (I believe the CA state tax is over 9% and I certainly don’t want to pay 

[Dave Foster]

@Brad Rondeau, the look back for the primary residence exclusion is that you must have lived in it for 2 out of the 5 years prior to sale.  So in oder to take advantage of the exclusion at all you'll need to move in for 2 years.

Second, because you are converting an investment property into your primary you're also going to have to recapture all the depreciation from the time it was an investment.  And when you sell you're going to have to prorate the gain between the periods of qualified use (as your primary residence (3 years) and the period it was a rental (8 years).  So you'd only get 3/8ths of the gain tax free.  

Between the time required to set this up and the burden of depreciation recapture and prorated gain it might be more worth your while to do a 1031 exchange.  Sell the property as it is an investment property, purchase new investment property and defer indefinitely all tax and depreciation recapture.