My wife bought our current home 5 years before we met. It’s still deeded in her name only. When we move, we want to convert it into a rental.
The problem is this: That house has appreciated by $200k since she bought it, and unless we sell within 3 years of moving out, we will have to pay capital gains taxes on that $200k.
My position on this, is that we should sell it and use the proceeds to buy a different rental so we can reset the tax basis. My wife is vehemently opposed to this and wants to keep it. She remains convinced that there must be a way to avoid the capital gains taxes.
I have an appointment with a tax attorney this week, but my own research says that we either sell within 3 years of moving, or we will owe the taxes when we eventually sell, even if that sale is 15 years from now.
15 Comments
Brass · February 20, 2023 at 10:48 am
It was my understanding that there is now a ,$250k for single and $500k for married filing jointly, tax break on the capital gains tax for selling a home.
https://www.investopedia.com/ask/answers/06/capitalgainhomesale.asp
Brass · February 20, 2023 at 10:53 am
After a little more reading I see the issue is with it becoming a rental property.
Divemedic · February 20, 2023 at 11:17 am
The issue is that to receive that break, you have to live in the house as your primary residence for 2 of the last 5 years. So, if you sell more than 3 years after moving out, you owe capital gains on the increase in value that accrued since you bought it, not just the increase that occurred since it became a rental.
joe · February 20, 2023 at 1:52 pm
isn’t it great how the little guy trying to get ahead always gets it in the ass…they can buy and sell stocks even as they write laws with impunity but who cares about the little guy trying to make a little money and hope to retire and not have to eat dog food for dinner…you will have nothing and like it…
Woody · February 20, 2023 at 12:03 pm
After reading your “GLAD” post, I’d sell now. Home value will decrease once the Low-Income homes hit the market as the “comps” will get factored into home values. Better to get the money out now and find a better investment.
Elrod · February 20, 2023 at 12:51 pm
Does it count if you sell it to an LLC within 3 years? (Divemedic Rental Properties LLC….)
Divemedic · February 20, 2023 at 1:58 pm
Sadly, no. As far as the IRS is concerned, an LLC is a “pass through entity” and is ignored. I also looked at selling to family and having them sell back to me, but that won’t work either.
I am thinking that an S corporation will be the way to go, but that is why I am going to talk to an attorney.
hh475 · February 20, 2023 at 2:40 pm
If it wuz me, I’d sell while property values were high. I made the mistake of keeping a place I bought for $360K. At one point, I was offered $750K fo rit, but thought I’d keep it as a possible reitrement home.
Then the 2009 crash came, and I needed money. I decided to put it on the market, and was getting offers in the mid to upper 200K. I ended up keeping the property until 2020. I sold it for more than I originally paid, but in the two decades I had the place, I had put enough money in upkeep and improvemets so that I still had a $50K loss, not counting inflation.
The other thing to remember is that profit on held properties isn’t as much as it seems because of inflation. That $360K in in 2001 dollars is $614K today, and I did *not* get that when I sold it.
Divemedic · February 20, 2023 at 3:36 pm
I want to reset the cost basis and hold it, if I can. Like the other house I own, it will generate rental income for as long as it is profitable to do so.
I can rent the two houses out for a combined $4,600 a month. The only issue is that taxes steal about 14,000 a year of that money.
Jonathan · February 20, 2023 at 4:01 pm
As far as the house sale and the capital gains tax, IIRC, the sale has to be arms length, which means it has to be publicly listed and not sold to family/ self to qualify, but I’m NOT an attorney or tax specialist.
As mentioned above, I’d sell it now while values are high, then I’d put the money in a fixed income fund while the economy moves. With that much to start with, there are some CDs and other options in the 5 to 8% range. I plan to do that later this year when our tenant buys our farm.
As an alternative, whenever you sell, you can time it to another property purchase and do a 1030 exchange – as long as you follow the rules, you pay no capital gains on the sell. If you do this, make sure to work with a lawyer experienced in them since the IRS looks closely at them.
Jonathan · February 20, 2023 at 4:10 pm
P.S. I don’t know a way to reset the cost basis and still keep control of it, but a good real estate lawyer may.
Divemedic · February 20, 2023 at 5:09 pm
Called some real estate attorneys, and they said I would need to talk to a tax attorney.
John · February 20, 2023 at 10:07 pm
I believe a 1031 exchange could be advantageous only if you keep the home then sell it after the 3 yr mark of renting. You could buy something else and roll the cost basis back in to the new property.
UnknownSailor · February 22, 2023 at 5:26 am
Capital gains aren’t paid until you sell the property, When you rent it you can use depreciation to offset some of the rental income. Track all your maintenance bills for upkeep, they go on the schedule E, and also offset rental income.
Divemedic · February 22, 2023 at 8:15 am
That’s not my issue here. The issue is cost basis. Let’s say that my wife bought the house 14 years ago for $200k. I convert it to a rental this year when it is worth $400k, then sell it 6 years from now for $450k. I would have to pay capital gains on the $250k ‘profit’ even though the majority of the increase in value happened when it was my primary residence. If I can reset that cost basis, then in the example, I would only owe capital gains on the difference between $400k and the $450k selling price.
That also applies to depreciation. I would have to pay a penalty to recapture the amount of depreciation I took when I sell it. A double tax, if you will.
The cost of maintenance and upkeep is immaterial for this discussion, because I can take that deduction whether or not I reset the cost basis.
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