There are many factors to consider when you turn your principal residence into a rental home. Knowing these factors can have a big impact on your tax bill since there are important tax benefits of selling both your principal residence and your rental property.
When you sell your principal residence, you may be eligible to exclude up to $500,000 in gain.
When you sell your rental property, you may be able to deduct any losses.
Let's look at some examples:
You live in your home for a least two years, then move out and turn the home into rental property. If there has been a significant increase in your home's value since you purchased it, you should look at selling the house within three years of converting it into a rental property. In that instance, you would meet the 2 out of 5rule. This means you have lived in your home for 2 out of 5 of the years prior to the date of the sale, and you still qualify for the exclusion of any gain. You will still pay capital gains tax on the depreciation taken when the property was a rental.
In this same example, if there has been a decrease in the value of the home, you may want to look at holding the home as a rental property for at least 3 years so that you can deduct any loss on the sale. Remember, when you sell rental property, you must include any depreciation taken in the calculation of loss. The depreciation taken is taxable so the amount of the deductible loss will be reduced by this amount.
For this next example, you have a rental property that has been rented for several years. The house has appreciated $20,000 since you purchased the home and you have made no improvements (increases to basis). You later move into this house as your principal residence. When you sell the house, you cannot include the $20,000 in your exclusion of gain. The $20,000 and the depreciation taken will be taxable.
Confused? Have questions? Call us, we can help you determine your best decision.