Question about capital gains

[Mandeep Randhawa]

Background info...I still live with my parents in Ca and I purchased an investment property April 2012 at auction. I purchased for 139,000. Eventually did a conventional loan (25%) and currently owe 90k. Similar homes have been selling for 240k. I have yet to file my taxs for 2012. I currently have renters in there now. I was thinking about doing a cash out refinance right now(pay down my student loan debt at 6.2%) and then sell the home in about 2 years and then purchase a home to live in.

So my question is if I sell a rental property and then purchase a place to live in...would I get hit with capital gains tax? I have heard that you have to be living in the property for 2 years for you not to get hit with capital gains if you are purchasing a property to live in...is this true? What's the best way to work around this?

Should I just sell my rental now and then purchase the house I want to evenutally live in(rent it out about 2 years) then move in? That seems like the least complicated way.

[Bill Exeter]

Originally posted by David Krulac:

Mandeep Randhawa

You can do that, do a section 1031, rent out the acquired property for a period of time (probably at least a year or two), then move in, Live there at least 2 years and then sell. If you are single and the CUMLATIVE gain from selling both properties is $250,000 or less no Federal tax due. It would be $500,000 if married (MFJ).

The statement above is not true. The ability to combine a 121 Exclusion and a 1031 Exchange was changed in 2004 and again in 2008. The 2004 change requires that property acquired through a 1031 Exchange must be owned for at least five (5) years before you can qualify for the 121 Exclusion. The 2008 change now requires that the capital gain be prorated between the number of years that the propety was held as non-qualified use (rental property) and the number of years that it was held as qualified use (primary residence).

So, if you complete a 1031 Exchange, acquire replacement property, rent it out for two (2) year and then live there for three (3) years so that you can say that you have owned it for five (5) years, 2/5ths of your gain would be taxable (the non-qualified usage) and 3/5ths would be tax free up to the $250,000/$500,000 limit (the qualified usage).

Hope this helps to clarify the issue.