All Forum Posts by: Peter J Donaldson

Thanks everyone again for your time in responding. I have been rather busy the last week and did not get a chance to reply. To @Zach White the reason we have to sell now is that the tenant announced they are moving out Mid-April, so I don't actually have a house with a sitting tenant to try to unload quickly. I have done that in the past with a different investment property and it worked out well for everyone. My current tenants are moving out Mid-April regardless of what I do with it. They have agreed to have our agent show the house, but as they are in the middle of a massive weeding out of possessions, they said they will not be ready to have anyone peruse the place until a month before (mid-March). It is unlikely we will find a buyer who can close within a month timeframe unless they are paying cash and have no other transactions tied to the deal.  I would entertain giving them a financial incentive to vacate early so I can still close within the 3 years, but I think that option is extremely unlikely due to the short time to find a seller and actually close before the official end of the lease. To @Bill B., unfortunately the reason they are moving out is because it was a fairly large family when they moved in and needed the space, but both parents had to move out to assisted living and the children grew up and moved out, so house is too big now for the renter. They have to downsize. I also self manage the property, so don't have a property manager with existing clients to talk to. To @Dave Foster, I would not try to trick the IRS into thinking I actually lived there. I was thinking that maybe you can call it a primary residence if you are not renting it, and are paying utilities, even if the house stays empty. I see that was way too simplistic a view though so that is a complete non-starter. I cannot consider moving back as I have a job out on the West Coast. On your suggestion about buying another investment property out here where we live now and moving into it as primary residence later, I mentioned earlier that is also unlikely due to the extremely high cost of living out here, would be hard to get anywhere close to covering costs, even with a sizable downpayment. I think I may have to look for a different type of investment property back in Florida (beachfront condo?) where I get more for my money and in a place that is likely more desirable to renters than a big house in the suburbs...

I would like to thank everyone for their advice, I think I have to forget about trying to sell in a way that allows me to take the cash and defer the gain, and just focus my energies on trying to tie down where my replacement property will be and how much more I have to sink into it personally to cover the "more expensive sale price than what I am selling" rule. I am not sure what the rules are for figuring how big a mortgage I can qualify for in terms of an investment property when I am also paying steep rent out west. I would rather not liquidate other investments to cover the difference between what I will walk away with and the final cost of a new place.

Peter

Dave,

thanks for the quick reply, and I guess I missed the detail on the partial exclusion qualification through a work move has to be the reason for the SALE, not the CONVERSION TO RENTAL PROPERTY, which is how I read it last night when I was obviously a little tired ;-(

OK, so if we do not qualify for the partial exclusion then I guess it is back to the question on whether if I go less than a month past the end of lease before selling, can I still claim 24 months of personal use in the previous 5 years, or would I have to round down to 23 months in which case my 'binary switch' on entitlement kicks in as soon as I go a day past the last day of the lease. I can also see if our tenants would move out a little early if we could secure a quick sale that could close before April 14th. 

I would still like a definitive answer from someone in the business on whether there is any flexibility in the sale date and how you calculate the 24 month period. Otherwise I may have to engage an accountant for some paid advice on how to move forward.

It was also suggested that as we are currently renting ourselves, maybe we can revert the house to be our primary residence for a while after the lease is up, and sell a month or two down the road and avoid capital gains through the $500K married exemption. I am not sure what paperwork has to exist to prove it is back to being our primary residence though as our jobs are in California, not Florida. I think some of the IRS rules on Capital gains and conversion between rental and personal property that I have been skipping over so far would likely also catch me on that plan though. 

If I am indeed facing a 1031 my focus may switch to identifying the best market in which to buy another property. I really wanted something closer to where we live in Northern California so we can at least check on it when we need. I do not think however that the economics work well, you are unlikely to cover your expenses as what you can command in rent may not cover a mortgage due to high real estate costs. As I said, I don't know exactly what I might get out of the sale, but it is hopefully going to around $400K ballpark if I can avoid capital gains. Prices are actually on the decline at the moment in the San Francisco Bay area, so not a good climate in which to invest money in real estate in my view. Buying an investment property is an area I am not familiar with is a little concerning.

Ok, I have read all the IRS publications and seen many forum answers on this basic subject and I THINK I now have an answer from IRS publication 523 but would like confirmation if possible as I think I have a quite rare scenario. Sorry for the long detailed post, but here is my situation:

• Bought a single family house in 2003 and used as primary residence until April 2016.
• Rented it and it has been rented continuously since.  Our tenant is coming to the end of their 3rd year leasing. In the middle of April 2019, it will have been rented for exactly 3 years. (I obviously have owned it for far more than the 2 years preceding).
• My tenant is moving out at the end of the lease
• So, let's say we decide NOT to rent it again, but sell it, manage to find a buyer and close (for example) 25 days after the lease ends, in early May.
• Then looking at the timeframe, for 3 years and 25 days prior to the date of sale, it was NOT our primary residence and for the previous 705, it WAS our primary residence.
• If the required 2/5 year ratio is exact to the day, then theoretically we do not meet the 2/5 ratio even a single day after the 3 years of rental expires. That then jeopardizes our ability to avoid the capital gains.
• The rules say you can specify months or days in the calculation of how much time it was your primary residence. Could I still say 24 months until we fall below the 23 month point around the middle of May, meaning I have 30 days grace before I am officially at less than the 2/5 ratio, or do you no longer meet the ratio when your period of primary residency goes down by just one day from the 730 days which would be the 2 year minimum within the last 5 years?
• Even if it is a hard line, I am thinking now that it may only be a hard line for whether you can avoid all the capital gain. Partial exclusion seems like it may be a possibility in my case.
• The same IRS publication says that even if you do not quality for the 2/5 rule (without clarifying how exact that ratio needs to be), if you move because of a work need, you can qualify for a partial exclusion:
  • You took or were transferred to a new job in a work location at least 50 miles farther from the home than your old work location. For example, your old work location was 15 miles from the home and your new work location is 65 miles from the home.
• This is in fact my situation. I took a new job in a different state and that was the primary reason for having to leave and rent the house. 
• The same question applies in terms of ratios for the partial exclusion though. The partial exclusion worksheet in Pub 523  says:
  • Step 1. Your time of residence in the home during the 5-year period leading up to the sale (and Step 1 also covers some other options that do not apply to me)
  • Step 2. Take the smallest period from Step 1 (you may use days or months) and divide that number by 730 (if using days) or 24 (if using months)
    
  • Multiply the result from Step 2 by $250,000. Stop here if not married filing jointly
    
  • Repeat Steps 1–3 for your spouse and add the two results
    
• If you can use fractions when you divide the primary residence period by 730, that means that If I close 25 days after the end of lease date then maybe my answer is 705/730=0.96 * $500K, so I can exclude up to $483K of the gain (also to be adjusted by the depreciation I have taken in the last 3 years). Is that correct? If it is 6 months after the lease expires then my answer is 75% so I can avoid $375K of gain adjusted by depreciation taken. In that case I don't really have a lot to worry about in terms of trying to close on a sale as soon as possible after the lease ends, as the percentage exclusion goes down relatively slowly.

Everyone's basic online answer always seems to go back to restating the 2/5 year ratio and I have an unfortunate case when the first opportunity to sell it is immediately after exactly 3 years of renting. Nobody has clarified that ratio question, not even really the IRS in my view. 

My quandry is whether I need to arrange a 1031 as part of the sale to avoid the gains, but then I am faced with identifying 3 properties within 45 days and closing in 180 days. I also do not think that there are many investment opportunities with the few hundred K I am likely to have out here in Northern California. I feel like I may be better keeping and investing the money in other ways for now until a better real estate opportunity arises if I can indeed avoid capital gains tax on the sale. 

Going down the 1031 exchange route could therefore leave me with a different problem if I cannot find anywhere new to buy. If I do NOT qualify for either full or partial exclusion of Capital gains I may have no choice though, as I cannot just let $150K or so just walk out the door to the IRS.

FYI I have been taking depreciation on the rental properly for the last 3 years - total about $37K. Potential gain on the house depends on selling price, but may have appreciated around $200-$220 (60-70%) since we bought it in 2003.

If anyone can put my mind at ease on the "less than 1.0 ratio" being allowed, I would be very grateful.