Selling a primary residence previously a rental tax exempt?

Question

Hi,

Thank you in advance for the replies. I have tried searching the internet for this answer, but have found a few different answers and I am not sure which one is correct, and none apply exactly to our scenario. My wife and i purchased a 2 family rental unit in 2012. We ended up moving into one of the units (the larger of the two) in June 2015. We are building a house which will be done late this spring and are debating between selling and renting out our 2 family unit, but we don't want to have to pay taxes on the gains, how much taxes we would have to pay will dictate if we rent or sell.

Since we have lived in the unit 2 of the last 5 years, do we not have to pay taxes on the gains if they are under $500,000? Do we have to pay taxes on the gains for the percent of the time we owned the property that it was a rental? What about depreciation we have taken? How does the fact that we never lived in the whole house, just one of the units affect this scenario?

Thanks in advance!

Daniel

Daniel B. · Answer

Thank you both for your response. I actually switched CPA's last year, and my previous and current CPA were giving me different answers. @Ashish

@Ashish Acharya your example is great. Any idea on if I can do a 1099 exchange with the difference/portion I would have to pay tax on?

Ashish Acharya · Answer

@Daniel B.

I am assuming this is a duplex.

Since you moved in after the house was rental, there is something called Periods of Nonqualified Use. Gain on the nonqualified use are not excludable under that 500k exclusion.

Simple example

You bought a rental home on January 1, 2012, for $200,000. On January 1, 2015, you convert the property into your principal residence, where you live until you sell the home on January 1, 2018, for $350,000. Your total ownership period is six years (2012-2017). However, the years 2012-2014 are a period of nonqualified use since the home was not principal residence during those years

Period of nonqualified use

3 years

Total ownership period

6 years

Total gain

($350,000 − $200,000)

$150,000

Nonexcludable gain

(3/6 × $150,000)

75,000

You must report a $75,000 gain for non-qualified use.

The remaining $75,000 ($150,000 − $75,000) of gain can be excluded under 500k exclusion

However, since half of the house was rented and your portion was also rented and depreciated, you have to prorate the taxable gain of 75,000 between two units. Once you prorate, you have to recapture depreciation on all the depreciation that you have taken so far on both units. Any gain left after the depreciation recapture is taxed at capital gain.

This is little simplified. Hope makes sense. Better get a CPA.

Selling a primary residence previously a rental tax exempt?

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