Sell or hold my residence

[Michael Clardy]

My wife and I own a house in California in which we have about $800K in equity.  However, in the twenty years we have owned the property, it has been rented out for 8 years.  We recently moved back into it as our primary residence.  My understanding of the capital gains exemption is that we would only be able to take a percentage  (12/20) of the $500K exemption once we live in it for another two years.  

We would like to buy a house out of state in which we would eventually retire. We would rent that house over the next ten years and then move into it once we retire.

We are trying to figure out if we should: 

a) reestablish our current hourse as a rental and then do a 1031 exchange

b) Stay in the current house for two years and sell it to buy the retirement home

c) sell in the next year without regard to the capital gain exclusion

d) ?

I would appreciate any insight into how to best use the equity in the current house to set ourselves up for a comfortable retirement.

Thanks.

[Michael Clardy]

Quote from @Bill B.:

I’m not sure how many of the previous responders read your post because they didn’t even ask obvious question number ONE….

1) How much of a capital gain will you have? (Net sales proceeds after all costs (PS. loan payoffs are considered proceeds.) minus purchase price is your taxable net gain. Your equity doesn’t matter one bit. If you pay the loan off before selling or do a refi and have $1 of equity, it won’t affect your taxable gain. 

2) if you stay 2 years you’ll have 14 years of personal use out of 22 years so 63.6% of the gain cane be exempted, up to $500k. So if you have more than a $786k NET GAIN (not cash, not equity, GAIN) you’ll be able to take the full $500k tax free and then do an exchange on the remainder. 

3) For that exchange to work you’ll have to buy an investment, not primary home that costs more than the remaining sales price, and reinvest all the “cash” beyond that $500k. Unfortunately being in CA they will hunt you down every year and make you confirm you haven’t sold the investment property. Because if you do, they are one of the few states that will require you to pay their tax after you’ve left the state. But if you hold it under it you die you’ll avoid their tax and the depreciation recapture you also owe. 

4) I’m not sure if you have to turn it back in to a rental for a year after those 2 years to qualify for a 1031 or if you’re rental history in the last 5 years qualifies you. That would be a question for a QI/expert like @Dave Foster. 

Congratulations on finally planing your escape. Good luck. 

 My gain is about $800 K.  

Thanks for the information!