Converting a rental property to primary residence?

[Paul F. Kershing]

I currently have a rental property with substantial assets gains.  Since I will hopefully be retiring within 2-3 years, how can I avoid potential tax consequences?  Can I opt to make it a primary residence?

[Dave Foster]

@Paul F. Kershing, You can.  You'll get to take the 121 primary residence exemption when you sell with some restrictions.

1. You'll only get to prorate the the gain between the time you lived in it (qualified use and tax free) and the time it was investment (non-qualified use and taxable).

2. You'll also have to recapture depreciation.

Another option would be to sell it and 1031 into a passive cash producing asset with a long lease life - a NNN property or a fractional opportunity that still qualifies for 1031 treatment. This way you get to go completely passive and enjoy your retirement. But you do it in a way so that rather than pay the tax you get to make money on the deferred tax. And when you pass away your heirs get the property stepped up in basis so the gain goes away and the property is tax free to them.