Converting from Rental to Owner Occupied

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Converting from Rental to Owner Occupied

Postby dreamjob9 » Wed Apr 03, 2013 4:07 pm

I am considering converting my rental property to owner occupied because we are moving back to the location of our rental property. Can anyone please explain the tax implications of such a move? We carried a 20k loss on the property for our 2012 taxes. Additionally, we will likely sell the house after 1 year due to another anticipated job change.

Thank you kindly!
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Re: Converting from Rental to Owner Occupied

Postby john94549 » Wed Apr 03, 2013 4:40 pm

I'm confused. Didn't you ask essentially the same question a few days ago? Anyway, my advice is the same.
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Re: Converting from Rental to Owner Occupied

Postby hand » Wed Apr 03, 2013 4:52 pm

john94549 wrote:I'm confused. Didn't you ask essentially the same question a few days ago? Anyway, my advice is the same.


No, Confused is someone else completely: http://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=38087
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Re: Converting from Rental to Owner Occupied

Postby damjam » Wed Apr 03, 2013 5:01 pm

To covert a property from non-qualified to qualified you will need to use the property as your principle residence for a minimum of two years out of the last five that you own it. So if you sell after one year you are not going to be able to claim qualified treatment for the property.
Therefore you will be taxed on the full amount of your capital gain.

To get started see:
Pub 527 "Residential Rental Property"
Pub 523 "Selling your Home" and
Pub 551 "Basis of Assets"
All and more are available at http://www.irs.gov/
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Re: Converting from Rental to Owner Occupied

Postby tj » Wed Apr 03, 2013 5:12 pm

hand wrote:
john94549 wrote:I'm confused. Didn't you ask essentially the same question a few days ago? Anyway, my advice is the same.


No, Confused is someone else completely: http://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=38087



No, john is right. There was another thread a few days ago.

viewtopic.php?f=1&t=113849
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Re: Converting from Rental to Owner Occupied

Postby dreamjob9 » Wed Apr 03, 2013 7:32 pm

tj wrote:
hand wrote:
john94549 wrote:I'm confused. Didn't you ask essentially the same question a few days ago? Anyway, my advice is the same.


No, Confused is someone else completely: http://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=38087



No, john is right. There was another thread a few days ago.

viewtopic.php?f=1&t=113849



I did ask the same question a few days ago. I received good advice, but not an answer to the tax question. I reached out to my CPA and he is booked until after tax day.
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Re: Converting from Rental to Owner Occupied

Postby dreamjob9 » Wed Apr 03, 2013 7:32 pm

damjam wrote:To covert a property from non-qualified to qualified you will need to use the property as your principle residence for a minimum of two years out of the last five that you own it. So if you sell after one year you are not going to be able to claim qualified treatment for the property.
Therefore you will be taxed on the full amount of your capital gain.

To get started see:
Pub 527 "Residential Rental Property"
Pub 523 "Selling your Home" and
Pub 551 "Basis of Assets"
All and more are available at http://www.irs.gov/


Thank you damjam.
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Re: Converting from Rental to Owner Occupied

Postby EmergDoc » Thu Apr 04, 2013 3:54 pm

Doesn't matter, you have a loss anyway, so no worries about paying capital gains taxes. Is there a claimable loss there? Hmmm...good question.

Per Pub 523 you can't sell your home for a loss and claim it. I'm still looking for whether that changes if it was an investment property a year sooner. I'm not sure.
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Re: Converting from Rental to Owner Occupied

Postby dreamjob9 » Thu Apr 04, 2013 5:44 pm

EmergDoc wrote:Doesn't matter, you have a loss anyway, so no worries about paying capital gains taxes. Is there a claimable loss there? Hmmm...good question.

Per Pub 523 you can't sell your home for a loss and claim it. I'm still looking for whether that changes if it was an investment property a year sooner. I'm not sure.


Thanks EmergDoc. I am doing all this moving because of med school, internship, residency and now fellowship. My wife bought the home before we had met and we rented it out of necessity. What I can't figure out is, since I have claimed the property has depreciated on my taxes over the past few years if I sell the property in 1 year for more than the depreciated value due I need to pay capital gains taxes on the difference?
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Re: Converting from Rental to Owner Occupied

Postby DetroitRed » Thu Apr 04, 2013 5:52 pm

I believe when you sell, you'll have to recapture the depreciation (pay 25% tax on all previously declared depreciation), even though it turned from a rental to your primary residence.
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Re: Converting from Rental to Owner Occupied

Postby SnapShots » Thu Apr 04, 2013 6:26 pm

What I can't figure out is, since I have claimed the property has depreciated on my taxes over the past few years if I sell the property in 1 year for more than the depreciated value due I need to pay capital gains taxes on the difference?


Yes. You will pay taxes on the depreciated value and capital gains, if it has increased in value.

The only way you can get rid of the depreciated value is to die and someone inherits the property. Or, you move in and make it your primary home. If you make it your primary home you must live in it 2 out of 5 years. If you leave in a year, why not keep it as your primary home for another year? You can live in another country and still claim it is your primary home.
Last edited by SnapShots on Thu Apr 04, 2013 6:30 pm, edited 2 times in total.
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Re: Converting from Rental to Owner Occupied

Postby Twins Fan » Thu Apr 04, 2013 6:28 pm

dreamjob9 wrote:Thanks EmergDoc. I am doing all this moving because of med school, internship, residency and now fellowship. My wife bought the home before we had met and we rented it out of necessity. What I can't figure out is, since I have claimed the property has depreciated on my taxes over the past few years if I sell the property in 1 year for more than the depreciated value due I need to pay capital gains taxes on the difference?


Yes, if there is a gain you will be taxed on that. Here is a somewhat simple explanation of it...

http://taxes.about.com/od/capitalgains/qt/recapture.htm

There is a formula to figure out the cost/basis/depreciation, but I don't fully understand it myself. The depreciation recapture at 25% is what hurts.

As mentioned, if you can live in the home for two years rather than one, you don't have to worry about all the depreciation stuff any longer and then you can sell it as your own home. Or, after one year if you have to move, you could look in the like-kind exchange, which I think is also called a 1031 exchange, where you basically trade your rental property for one like it in another area. Then you could move into that other property. Another option to avoid all the tax stuff of selling a rental property.
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Re: Converting from Rental to Owner Occupied

Postby SnapShots » Thu Apr 04, 2013 6:35 pm

Twins Fan wrote:
As mentioned, if you can live in the home for two years rather than one, you don't have to worry about all the depreciation stuff any longer and then you can sell it as your own home. Or, after one year if you have to move, you could look in the like-kind exchange, which I think is also called a 1031 exchange, where you basically trade your rental property for one like it in another area. Then you could move into that other property. Another option to avoid all the tax stuff of selling a rental property.


This would also work. The feds are quiet on how long a rental has to be a rental. Theoretically, you could sell the rental property, buy a house, say it's a rental, move in, make it your primary home and not have to pay depreciation or capital gains taxes.
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Re: Converting from Rental to Owner Occupied

Postby damjam » Thu Apr 04, 2013 6:44 pm

SnapShots wrote:This would also work. The feds are quiet on how long a rental has to be a rental. Theoretically, you could sell the rental property, buy a house, say it's a rental, move in, make it your primary home and not have to pay depreciation or capital gains taxes.


I think you always have to recapture depreciation. In addition the capital gains has to be apportioned between non-qualified (rental use) and qualified (primary residence use).
See this quick summary.

I've only begun to research this area and I would love to be wrong on this.
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Re: Converting from Rental to Owner Occupied

Postby dreamjob9 » Thu Apr 04, 2013 8:37 pm

Great discussion.

Let me throw in another kicker. I will be living in the house from June 1st 2013 to July 1st 2014. Although, that is only one calendar year it overlaps considerable with both 2013 and 2014 tax years. Could this qualify as 2 years, thus eliminate the 25% taxes on recapture of depreciation and capital gains?
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Re: Converting from Rental to Owner Occupied

Postby Twins Fan » Thu Apr 04, 2013 9:20 pm

My guess is that as far as the IRS is concerned you will need two years taxes done with no rental income or depreciation claimed. So, when you do 2013 taxes and claim some depreciation and report the rental income from January to May, that year probably won't count for a full year of "primary residence".

I'm only guessing here though.
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Re: Converting from Rental to Owner Occupied

Postby damjam » Fri Apr 05, 2013 12:43 pm

dreamjob9 wrote:Let me throw in another kicker. I will be living in the house from June 1st 2013 to July 1st 2014. Although, that is only one calendar year it overlaps considerable with both 2013 and 2014 tax years. Could this qualify as 2 years, thus eliminate the 25% taxes on recapture of depreciation and capital gains?

From IRS Pub 523:
Factors used to determine main home. In addition
to the amount of time you live in each home, other factors
are relevant in determining which home is your main
home. Those factors include the following.
1. Your place of employment.
2. The location of your family members' main home.
3. Your mailing address for bills and correspondence.
4. The address listed on your:
a. Federal and state tax returns,
b. Driver's license,
c. Car registration, and
d .Voter registration card.
5. The location of the banks you use.
6. The location of recreational clubs and religious organizations of which you are a member.


And as I said earlier AFAIK you must always recapture depreciation, even if you successfully convert the rental property to personal use. You will also need to apportion part of your gain to rental activity and part of your gain to personal use on a pro-rata basis. To the best of my knowledge the rules that used to allow the conversion of rental property to personal use and thereafter exempted the capital gain were changed in 2008.

The rules regarding the sale of property that has been converted between rental and personal use are complex and are very much dependent on your particular fact pattern. Other than a CPA or EA, the publications I mentioned earlier are your best source for information.
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Re: Converting from Rental to Owner Occupied

Postby john94549 » Fri Apr 05, 2013 8:02 pm

OP really might spring for a tax pro.


viewtopic.php?f=1&t=113849&p=1655542#p1656056

As noted days ago, might I add.
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Re: Converting from Rental to Owner Occupied

Postby damjam » Fri Apr 05, 2013 10:18 pm

I now see from the not-so-old thread that the property used to be the OP's principle residence. This may fit Example 1 on page 15 of Pub 523, if the property meets the 2 yr out of 5 yr rule.

However, if the property will have been rented out for 3 years or less the OP should heed Example 2 and consider selling the property rather than moving back in.

The precise facts of the situation make all the difference.
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Re: Converting from Rental to Owner Occupied

Postby SnapShots » Sat Apr 06, 2013 8:54 am

damjam wrote:
SnapShots wrote:This would also work. The feds are quiet on how long a rental has to be a rental. Theoretically, you could sell the rental property, buy a house, say it's a rental, move in, make it your primary home and not have to pay depreciation or capital gains taxes.


I think you always have to recapture depreciation. In addition the capital gains has to be apportioned between non-qualified (rental use) and qualified (primary residence use).
See this quick summary.

I've only begun to research this area and I would love to be wrong on this.


I looked into it and was going to do it but plans changed and didn't. Now I see there is some conflicting information from what I was told. Once you get into real-estate rental business, it's for life. It's one 1031 exchange after another.
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Re: Converting from Rental to Owner Occupied

Postby dreamjob9 » Sat Apr 06, 2013 9:20 am

damjam wrote:I now see from the not-so-old thread that the property used to be the OP's principle residence. This may fit Example 1 on page 15 of Pub 523, if the property meets the 2 yr out of 5 yr rule.

However, if the property will have been rented out for 3 years or less the OP should heed Example 2 and consider selling the property rather than moving back in.

The precise facts of the situation make all the difference.


The property was our primary residence, however it has been rented out for 5 consecutive years.

Precise facts:

Original purchase price- $169,500
Estimated adjusted cost basis - $149,000
Carrying Passive loss forward - ~ $-24k
Current appraisal value - ~ $141,000

We plan on moving into the house for 1 year (6/1/13 - 7/1/14) and then sell vs continue renting for 1 year then sell.

Does this help? Btw, I really appreciate everyones help!
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Re: Converting from Rental to Owner Occupied

Postby SnapShots » Sat Apr 06, 2013 9:49 am

http://firstexchange.com/node/23
In accordance with the 1997 Taxpayer's Relief Act, it should also not be forgotten that depreciation recapture taxes will still be owed for the portion of time the house was used as a rental property after May 6, 1997. For example, if a Taxpayer acquired a house through an exchange five years ago, rented the house for three years, and has now lived in it the last two years, gain may be excluded under IRC Section 121, but taxes will still be owed on the total amount of depreciation taken or allowable for those three years the house was held as a rental.


My reading from the above article.

The IRS caught on to the loophole regarding 1031 exchange conversions to primary homes and changed the rules. Still can be a good deal.

It looks like you will have to make that rental your primary residence for a minimum of 2 years.

After living it for 2 years you won't owe capital gains. But, you will have to pay taxes on depreciation taken while it was a rental. :annoyed

You don't have to actually live in the house, to claim it as your primary residence. You will need to keep your cars registered in the state, vote there, etc. You could hold on to it and sell after the second year, if the tax hit is worth the wait. Of course, you can't rent it out or claim another home some where else as a primary residence.

Or, do a 1031 exchange and buy another like invest property where you going.
Last edited by SnapShots on Sat Apr 06, 2013 10:09 am, edited 2 times in total.
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Re: Converting from Rental to Owner Occupied

Postby jared » Sat Apr 06, 2013 10:02 am

As damjam has been saying all along, you're stuck with the depreciation recapture unless the house is sold for less than adjusted basis. The section 121 gain exclusion does NOT apply to recognition of gain attributable to depreciation.

121(d)(6) Recognition of gain attributable to depreciation.— Subsection (a) shall not apply to so much of the gain from the sale of any property as does not exceed the portion of the depreciation adjustments (as defined in section 1250(b)(3)) attributable to periods after May 6, 1997, in respect of such property.
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Re: Converting from Rental to Owner Occupied

Postby SnapShots » Sat Apr 06, 2013 10:24 am

From your figures doesn't look like you'll have any capital gain, so no need to worry about making it your primary residence. Since the property actually depreciated, you may owe some depreciation tax, but doesn't look like it will be much.

Your accountant should be able to give you a ball park figure.
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Re: Converting from Rental to Owner Occupied

Postby john94549 » Sat Apr 06, 2013 12:39 pm

A true Boglehead dies with a fully-amortized rental in his or her estate*, after having used up all the booked loss as an offset on line 17, Form 1040 (check out Form 8582; it's a hoot). On one's tombstone, writ large: "Recapture? What Recapture?"**

Hint: Social Security doesn't count towards MAGI. Gotta keep those RMDs in check, though. Use it or lose it. Roths are suggested by some, but I like the idea of just blowing through the money. Up to the maximum of the minimum, as it were (MAGI $100K).

True Bogleheads also wrap their arms around Garn-StGermain and re-finance for the benefit of heirs.

Trivia.

*Preferably cash-flow positive.

**I've always wondered if successive generations could amortize the same rental over, and over, and over again. And never get "captured"? I suppose Alexandra, Isabella, Samantha, and Owen (our grand-children) will know. They have smart parents.
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