TaxMama Rental Property Tax Law and Information


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Capital Gains Tax on Rental Property

  - Home Also Rented
  - Relocation Proration
  - Sold Vacation Home
  - Re-establishing
    Residence
  - "Temporary"
    Absence
  - Minimizing Gains
  - Fair Exchange

Rental Property Tax Deductions

Depreciation of Rental Property

Mixed-Use Residential Property

IRS Forms


Capital Gains Tax on Rental Property

When, and How, to Report Capital Gains on the Sale of Residential Rental Property



The Basic Rules:

  • Each person living in a home they own may sell their personal residences, and pocket up to $250,000 in profit without sharing with Uncle Sam. That means, if three people live there and are on title - you don't pay capital gains tax on the first $750,000 of profit.

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  • For a residential property to qualify as a residence, owners must live in it for a minimum of 2 years. Any two years out of five will qualify.

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  • You can rent out your property and move back into it before selling it. If you live in your home for 2 years out of the last 5 years before you sell it, you will qualify for the personal residence exclusion.

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  • If you used your home for business, or rented out any part of it during the time you owned it, even though you may not have to pay any capital gains taxes, you will have to pay tax on the depreciation of the business part of the usage.

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  • If you never depreciated the house while you rented it or used it for business, that's a big mistake - and you'll still have to pay tax on the depreciation you should have taken. (But there's a fix for that - and you'll have to Ask TaxMama how that works )

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  • BONUS TIP: You may rent out your home for up to 2 weeks out of each year without having to pay tax on the income or having to treat any part of your house as rental property when you sell it.
  • Home Also Rented  

    Dear TaxMama:

    I bought a home in 1984 as my residence. I was transferred in 1991 and had to rent it due to there being no market for home sales.

    It was rented (rental property schedule E) until 2001, when I retired and sold it.

    Do I declare the profit on the sale on Schedule D or on Form 4797?

    I have done both with Turbo Tax. Schedule D seems complicated, and Form 4797 seems too simple.

    Michael

    ••• Tax Mama Replies •••

    Hi Michael,

    You're right. Sales of rental properties go on Form 4797. The profits will be taxed, essentially, at the 25% rate.

    And you think it seems simple? How interesting.

    Many of us struggle with the subtleties. ;~)

    Please be sure you take into account any depreciation recapture.

    Remember to include in the cost, all the costs of the purchase (your original escrow statement), any refinancing over the years, the costs of your sale (your current escrow statement) that weren't deductible on your Schedule A as interest or property taxes.

    Remember to include all of the improvements you made while it was still your personal residence. (Unless they've already been fully depreciated.) Looks like you've got the hang of it!

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    Relocation Proration

    Dear TaxMama,

    Last year (1999) we sold a rental property. We originally bought the home for our primary residence. We lived in the home for one year and one month.

    My husband at that point was relocated for his job to Vermont. We rented out the property and moved. We rented the home for over a year, and then decided to sell it, because we found out that we would be staying in Vermont longer than anticipated.

    Our accountant is now telling us that we will owe a sufficient amount of taxes (thousands) due to the sale of the rental.

    My question: Aren't there laws to protect people that are required to relocate due to their jobs? We did not buy the property with the intention of renting it.

    If there are any tax laws you may know of, please let me know.

    Thank you.
    Cara

    ••• Tax Mama Replies •••

    Hi Cara,

    You're right. There are provisions for people who move.

    You can still treat it as a personal residence, though you may have to prorate the gain for the lesser portion of the two years that you might have lived in it.

    There is a reduced personal residence exclusion if you lived in it for less than two years. (prorate 13/24 x 500,000 - and I don't think your gain was that high)

    And yes, you may rent the house out for up to two years after you move, and still have it be your personal residence. You will have to recapture the depreciation part of the cost. Since it was not your intention to turn it into rental property, just a stop gap until you could sell it, you do not have to treat it as a business property. (As long it was under two years after you moved out, which it was).

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    Sold Vacation Home  

    Dear TaxMama,

    I have a question that I hope you can help me with. It's regarding capital gains tax and rental property.

    I currently live in Jacksonville, Florida, and I'm renting a home here. I've been in this rental house for 5 years.

    I have a home in Savannah Georgia that I purchased in 1991, that I just recently sold. The house was not used for rental property, but as a place for us to stay at while visiting in Savannah.

    I sold my house in Savannah for $97,000, less the Realtor fee of $4,850.00 and $1,000 in repairs netting approximately $91,150.00. I had a mortgage for about $62,500.00. At closing, I was given a check for approximately $28,500.00. Do I have to pay capital gains on this money?

    Thanks,
    Timothy C. T

    ••• Tax Mama Replies •••

    Hi Timothy,

    This question reminds me of the riddle about the bus - it is going southbound on Park avenue, 12 people get on at the first stop, 3 get off. 4 people get on at the next stop, and 2 people get off. 6 folks get on, and 4 off, at the next stop. Got it all?

    Now, the question is, "What color is the bus driver's eyes?"

    My answer to you - is I haven't a clue!

    If the home was not your principal residence (was it?), you are not eligible for the $250,000 exclusion on the sale.

    If it was an 'investment' property, the amount of cash you received from the net sale doesn't matter.

    The main numbers you left out were in the first part of the equation - Purchase cost and Costs of Improvements.

    Subtract those from the sales price, less selling costs and you have your taxable profit - or loss.

    The second piece of missing information is your tax bracket: The capital gains rates change depending on your income level (10% - 25%)

    Publication 544 has lots of information on the subject: Publication 544 - Sales and Other Dispositions of Assets

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    Re-establishing Residence  

    Dear TaxMama,

    We are considering the sale of our rental house, which we have rented out since May, 1987. I understand that it would be to our tax advantage to sell our principal home, and move back into the rental home for a minimum of 2 years.

    I understand that we could then sell the rental house as a principal residence and avoid some hefty taxes on the gain. Do you have any ideas or suggestions?

    Francine

    ••• Tax Mama Replies •••

    Dear Francine,

    That's what I try to advise my clients to whenever possible.

    First of all, you can sell your present home and pocket the profits, up to $500,000 for both of you, filing jointly.

    Then, you have to live in your former rental property for at least 24 months. When you sell it, once again, you can avoid paying taxes on $500,000 worth of profits. And you will need that cushion.

    You see, if you have been depreciating that property since 1987, you have already written about half of the building's value. So all of your depreciation will be deducted from the original cost of your home (plus improvements) in order to arrive at your profit.

    When you get ready to sell that house, be sure to have a Tax Pro handle the computations so they are done properly.

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    "Temporary"Absence  

    Dear TaxMama,

    IRS Publication 523 states that the owner of a residence seeking the one- time tax exclusion may be permitted "short temporary absences" during the 3 years he has lived in the home prior to the one-time sale at age 55 or older.

    A one year absence is NOT considered a "short temporary absence".

    Do you have any idea how one may determine what length of absences would qualify, and how many could the taxpayer take within that 3 year period?

    In this case, the taxpayer has owned the property for many years as rental property, and he would like to make it his "main" home, and have the freedom to move about in other parts of the country while he was getting his two years of "use" in. Then he would sell it.

    Could his "physical" absences be tolerated taxwise?

    Thanks for your help.
    Milton Abramson

    ••• Tax Mama Replies •••

    Hi Milton,

    Being over 55 is no longer an issue now that the exclusion is $250,000 per person. (And $500,000 per couple)

    But there is another provision you overlooked:

    Period of ownership and use. The required 2 years of ownership and use (during the 5-year period ending on the date of the sale) do not have to be continuous. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 2) during the 5-year period.

    Many seniors live in care or convalescent facilities for their final years. Generally, they are still considered as being residents of their own home during that time.

    So, it seems to me that as long as your friend gets the two years in during a five year span, he'd qualify.

    However, for it to be his principal residence, that's where he'd have to be getting his mail, the address on his tax returns, voter registration, etc.

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    Minimizing Gains?

    Dear TaxMama,

    I have a second house that I used to live in, and I have been renting it out for the past 8 years. I have filled out the appropriate Schedule C (?) each year claiming my rental income, depreciation expense and other expenses.

    I am interested in selling and wondering what would be the best way to save myself a few bucks as far as capital gains taxes, etc.

    First, do I qualify for the one time exclusion since this will probably be the only house I sell?

    Secondly, how do I calculate my gain, since I have already taken depreciation? I expect the house to sell for about $50,000 more than what I paid for it.

    Also, how do I figure out my basis to calculate the gain? The house has been vacant for about 6 months. Should I list it as a secondary residence for capital gains exclusion purposes?

    Feel free to answer any or all of the questions, or maybe point me in the right direction for reference.

    Thanks for your help.
    Patricia

    ••• Tax Mama Replies •••

    Hi Patricia,

    Hopefully, during the past few years, you have been using Schedule E (not C) to report the rental income.

    Unfortunately, since you've not lived in the house for so long, the personal residence exclusion won't apply to you.

    Of course, if you move back in for two years, then, sell it- you could have all the profits tax-free.

    There is a matter of the depreciation you have taken for all the years that it was a rental. Unfortunately, since the law keeps changing on this matter, it would be necessary to research how to handle the taxability of those deductions if you convert the house back to your home in the year that you do sell it.

    Right now, if you sell it, your gain is higher than you realize.

    It works like this - Example
    Start with the purchase price of the house
    $100,000
    Cost of land (if not included above)
    25,000
    Cost of improvements, remodeling
    10,000
    Costs of loans and refinancing
    3,000
    -------------
    Subtotal
    $138,000

    Then, deduct the amount
    of depreciation taken over the years on: House
    ($29,000)
    Improvements
    (10,000)
    Loan
    (800)

    Net Tax Cost (basis)
    $98,200

    If you are selling it for $50,000 more than you paid for it , let's say
    $175,000
    Less commissions/selling costs
    (15,000)

    Your taxable profit would be:
    $61,000

    Of that, $39,000 might be ordinary gain - taxed at your highest tax rate. and only $22,800 would be at capital gain rates.

    So, there you have it. More than you ever wanted to know.

    Ready to move back into the house for two years?

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    Fair Exchange

    Dear TaxMama,

    I have a friend who is part owner of a home with her mother (50/50). The home is being sold with a large gain- 200,000 each. My friend has not lived in the home, nor has she collected rent, depreciated the property or claimed any expenses.

    They want to roll this gain into a rental on a 1031 exchange, does this qualify as investment property?

    Thanks,
    Jim E

    ••• Tax Mama Replies •••

    Hi Jim,

    Your friend's part of the home certainly qualifies. The mother's I'm not sure. But, it might.

    For the amount of tax at stake, it's well worth the cost to have a tax professional research it.

    However, if they both live in the home and have been there for over two years, they can each take advantage of the $250,000 exclusion on the profits from the sale.

    That amounts to $500,000 combined. Is their profit really more than that?

    They may be able to keep all their profits without having to do any exchange AND they may be able to buy anything they want with the proceeds.

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