Tax Strategy for Long Term Residence turned Rental, then Sale?

[Brian Kelley]

Hello everyone. I am getting back into RE investing and took the first big steps at the end of 2016. I’m curious about my tax strategy for the 2016 tax return in progress and also interested in a referral to a very good CPA in the Seattle area with expertise in real estate investing. Here’s my basic story:

I've owned my house for 20+ years and lived in it continuously but my family needs have been evolving and I have been wanted to sell it and move to something that fit better. This fall, a chance conversation with a colleague at work resulted in an agreement that her family would rent my house so I could purchase something different and move. We also agreed that they would purchase the house in the spring after her husband had been at his job for a year to satisfy the VA requirements for his financing. While this isn't a typical lease-option, we came up with an unusual agreement separate from the formal rental agreement needed for my new mortgage.

The house needed some updates so we agreed on an as-is price for the house as it sat. From there, I agreed to fund the rehab to their specs, working together with sweat equity and vendors she has access to through work. They have agreed to purchase the house for the ‘as-is price’ plus the cost of the improvements. We have been working together and it has been going to plan and on budget. I’m in my new house and they are in their new house. This is working well because they are choosing finishings they like but are essentially absorbing the full net cost when they buy.  Any incidental purchases they pay for out of pocket are just equity in their home. I got out of my old house without the need of bridging the gap between moving out and selling while relocating my family and am selling my house for pretty much market value off market so I save a ton in commissions. This is a true win/win and we are planning on working together on a few more investments after our collective families and finances ‘heal’ from this process.

My new house closed the first week in December and the lease started on December 20th so I have legitimate rental income for 2016. I also have about $25,000 in legitimate rehab costs also in 2016 that I can argue were necessary to move the new tenants in. These include rearranging some rooms, new floors, doors and trim, remodeling of two bathrooms and new paint and fixtures throughout.  My tentative plan was to have my fledgling rental business show a huge loss in 2016 and then sell the property in 2017 without having taken much depreciation and paying no capital gains since it was my primary residence so recently.

With these broad parameters in mind, what pitfalls am I missing? What details have I left out? I have around $20k in FWT sitting on my W2 just begging to be liberated. Cheers!

-Brian