Avoiding Capital Gains Tax While Renting Out Your House

by on March 22, 2012Jason Van Steenwyk

how to avoid capital gains tax when renting out your houseFirst, the bad news. The IRS levies a capital gains tax of up to 15 percent, depending on your tax bracket, on the profitable sale of investment property. Furthermore, investment property does not normally qualify for the capital gains tax exclusion on up to $250,000 in capital gains ($500,000 for married couples filing jointly) that personal residences typically enjoy.

That exclusion’s worth a pretty good chunk of change. Assuming the top long-term capital gains rate of 15 percent, that adds up to as much as $37,500 for single owners, and double that for married couples. That’s enough to warrant doing some tax planning to mitigate the tax hit. You may not be able to avoid it altogether, but you may be able to take the edge off of the bill.

Know the Capital Gains Tax Rules

The good news is that once you rent a property out, it is not forever doomed to be treated like an investment property, subject to capital gains taxes on the first dollar. You can convert a property’s status from an investment property to a personal residence by satisfying the IRS’s simple use test: To claim the exemption, you must have lived in the property for at least two years out of the preceding five.

The simplest way to avoid the capital gains tax, then, is to live in the home for at least two of the five years immediately preceding the sale.

Use Section 1031 Exchange

The “landed gentry” has occupied a place in Congress since the dawn of the Republic. It’s not surprising, then, that they would write a landlord-friendly provision or two into the tax code. In fact, Congress has given real estate investors a gift not normally available to retail investors in stocks, bonds and mutual funds: a deferral of capital gains tax on exchanges of one property of “like kind” for another. For example, you can sell a residential rental property and buy a new one in exchange, under Section 1031.

To qualify, the property you’re selling and the property you’re buying must be of “like kind.” They don’t have to be identical – they just have to be in the U.S., and serving approximately the same function in your overall portfolio. Generally, you can exchange U.S. real property for another U.S. real property and defer capital gains tax under section 1031.

What Qualifies for Capital Gains Tax Deferral Under Section 1031?

There are some special rules that apply. The two properties don’t have to change hands at the same time, as would be the case with a direct swap, says the IRS. Instead, with a deferred exchange, “the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property.”

Additionally, you can’t defer capital gains in a personal residence under Section 1031. Both of the properties must be business or investment properties. Vacation homes don’t count. This provision only defers capital gains on one property. Your tax basis in the old property transfers to the new one.

Careful – Section 1031 only applies to the property itself. If you own the property within partnership, you cannot sell your interest in the partnership to avoid capital gains tax.

How Long Do I Have to Execute a 1031 Deferred Like-Kind Exchange?

There are two time limits you need to worry about: You have to identify your new property, in writing, within 45 days of selling the old one. You also have to deliver your identifying document to an intermediary whose function is to ensure that the 1031 exchanges are actually realized. “Notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient,” warns the Internal Revenue Service.

Second, you have only 180 days after the sale to complete the acquisition of the new property, or until the due date of your income tax return, including all extensions. If you blow either deadline, plan on paying the entire capital gains tax. The IRS does not grant waivers to these timelines, except for presidentially-declared disasters.

For more information on like-kind exchanges under Section 1031, see IRS Publication 544.

Sell a Loser

If you have investment property to sell at a profit, potentially generating a capital gains tax liability, look to see if you have any investments that have lost money. If you do, you may be able to offset some or all of your capital gains tax, using a technique called “tax loss harvesting.” The IRS aggregates all your gains and losses for the year. So selling losers can help you lower your capital gains tax bill. Furthermore, if you have excess losses, you can deduct up to $3,000 from your income, and carry this loss forward every year, deducting your loss against any capital gains, and then up to $3,000 of ordinary income, until your losses are exhausted.

Time the Sale

If you must pay the capital gains tax, consider doing so when your income is low. Why? Because your capital gains tax is a function of your income tax bracket. The lower your taxable income, the lower your long-term capital gains tax is likely to be.

For that reason, the best time to sell a property you’ve been renting is when your net taxable income, after deductions, is abnormally low. Try to bunch deductions in the same year, and shift income out of the year.

Use a Deferred Sales Trust

If you are unable to find a suitable like-kind property, or execute the transaction in time to qualify under Section 1031, or you simply want to get out of real estate, you may consider establishing a deferred sales trust (DST). The buyer funds an annuity held within the trust. The trust sends the income stream to you, according to a schedule that suits your income needs. This allows you to defer capital gains tax by taking your sales proceeds in the form of installment payments, in what the IRS deems a “structured sale” under IRC Section 453. You only pay the capital gains tax gradually, as you receive the payments from the trust.

Enlist!

Five years not enough? Join the military! If you are on active duty, and you are called away from your home on orders from Uncle Sam, you can “stop the clock” on the IRS’s use test for up to 10 years. Short of that 10-year limit, the IRS does not penalize members of the military for being called away from their homes of record on military orders. However, if this provision applies, you must still have lived in the property for at least two years of the previous 10 years to qualify. However, you cannot use this provision more than once every two years.

{ 86 comments… read them below or add one }

Dave September 26, 2014 at 4:14 pm

Hello and thank you for your very helpful responses at this site!

I have a question regarding the Housing Assistance Tax Act of 2008 and how it may impact my Capital Gains exclusion upon sale of my property.

My wife and I owned and lived in our home from 2003 to 2013 as our primary residence. In November 2013, I moved for work and we converted our home to a rental. If I continue to rent the home and then sell prior to November 2016, will we still qualify for $500k in capital gains exclusion (because we lived in the home 2 of the prior 5 years preceding the date of sale), or will we have to pay capital gains on a % of our gains because of the Housing Assistance Tax Act of 2008 (since the property was used as a rental subsequent to Jan 2009)?

Thank you!

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Jeannette September 29, 2014 at 2:36 pm

Hi Dave and you’re welcome,

Good question. If you meet the “2 out of 5” use test, then yes, you will qualify for the capital gains tax exclusion. But at the same time, as a result of the Housing Assistance Tax Act of 2008, you will have to pay capital gains tax on a percentage of the gain on the sale of your main home if you have a period of nonqualified use; the bigger the period, the less that is subject to the exclusion.

The Housing Assistance Tax Act of 2008 changed the rules on how much of the gain from the sale of a primary residence can be excluded from taxation. I don’t like to muddy the waters when writing in a forum such as this so I remind people that they can exclude up to the IRS’s maximum amount. But since you mentioned it, here goes……

IRS guidelines say, “You can exclude up to $250,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home [if you meet the ownership and use tests].” Nonqualified use means any period beginning on or after January 1, 2009 where neither you nor your spouse used the home as a main home. Non-qualifying use prior to January 1 is disregarded when calculating the capital gain allocation.

The amount of gain that will qualify for the exclusion then is based on the amount of time of qualifying use. Qualifying use is the amount of time that you did occupy the home as a main home.

Non-qualifying use is expressed as a percentage of total use of the home over the five year period ending on the date of sale. For example, if you rent out a home for 3 years and live in it for 2, then your ratio of nonqualified use over the last five years is 3/5 or 60% and your percentage of qualified use is 40%. Thus, if your net gain subject to allocation is $100,000, then $60,000 is taxable capital gain and the remaining $40,000 is subject to the exclusion.

Your non-qualifying use began less that a year ago, so my suggestion would be to sell the property as quick as you can. That way, your unqualified use percentage will be less and more of your gain will be subject to exclusion. You may want to consult IRS Publication 523 for more details. Good luck.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Shirley September 19, 2014 at 2:33 pm

Hello,
My husband & I are selling our primary residence and moving to our rental house that was purchased in 1978. Therefore converting a rental to our primary residence. How long do we have to live there before we can sell and exclude the capital gains tax, 2 years, 5 years? It is confusing to say the least.
Thank you

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Jeannette September 22, 2014 at 4:33 pm

Hi Shirley,

Since you’ve owned the rental house for more than two years, the answer to your question is at least two years. Please refer to my reply to Kathy’s situation below for further details.

But also note that the IRS only allows you to use the gain exclusion once every two years. So if you will be excluding gain from the sale of the residence you are currently selling, then be very aware of your time frames so that you don’t violate their rule.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Kathy September 19, 2014 at 12:23 pm

I bought my house in 2008 as a primary residence. Due to a job transfer, we moved and rented out the house in January of 2012. The tenants have been there for close to three years, and are moving out soon. If I want to take advantage and not pay capital gains, do I have to sell my house before January of 2015? It is currently September 2014, and being in the Northeast, I’m not sure if I can get my house sold and settled within three months during the colder months.

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Jeannette September 22, 2014 at 4:17 pm

Hi Kathy,

By my calculations, no, you do not HAVE to sell your house before January of 2015. But I don’t know exactly when you moved out and when you’re going to move back in.

The IRS requires both an ownership and a use test to determine if you can exclude the gain on the sale of a home from taxation. Both tests have a two year requirement based on the DATE OF SALE of the home.

According to the IRS, you must have owned and lived in the home for at least two years during the five year period that ends on the date of sale of the home. Luckily though, in the case of living in the house, that two year period does not have to be continuous. Meaning, if you live in it for 20 months then move out for 36 months, then move back in again, as long as you live in it as your main home for at least another 4 months before you sell, you should then be able to meet the two year requirement.

To make a determination in your case, you need to work backward from the anticipated selling date. I suggest you draw a time line and then do the math. If, for example, you sell the house on Dec 31, 2014, then the five year period ending on that date began on Jan 1, 2010. If you don’t think you’ll sell the house until March 31, 2015, then the five year period began on April 1, 2010.

I recommend you consult IRS Publication 523 for the full scoop on selling your home. Then if you still have a question, consult a qualified tax accountant in your area.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Mariyana September 14, 2014 at 8:37 am

I bought a condo in 2011 and it has been my primary residence for the last 3 years and it is only under my name. My boyfriend and I are moving to Seattle for a promotion and will be renting an apartment so the condo will still stay as the primary residence. If I rent out my condo for less than 6 years and decide to sell would I still have to pay CGT? Also if we decide to move back home and move back into the condo how long would I have to live in it again so I could avoid paying CGT? Thanks!

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Jeannette September 16, 2014 at 12:33 pm

Hello Mariyana,

The IRS’s use test for exclusion of capital gains from taxation says you must have LIVED in the home as your main home for at least two years during the five year period ending on the date of sale of the home. If you move to Seattle and LIVE in an apartment there, you are no longer LIVING in the condo even though you may consider it your primary residence.

So, if you rent out the condo for more than three years during the five year period ending on the date you sell it, then yes, you will be subject to capital gains tax if you do in fact recognize a gain on the sale. Luckily though, the two year period does not have to be consecutive. So you could conceivably live in the condo for 12 months, rent it out for 48 months then live in it again for 12 months (or any similar combination of months) just before you sell it and meet the IRS’s use test.

I recommend you consult IRS Publication 523 and review the section on excluding gain so that you fully understand the rules before you embark on your move to Seattle. Good luck. (I was just in Seattle. It’s really lovely there.)

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Joe September 11, 2014 at 11:48 am

I purchased a home in April 2006 for 180k as my primary residence. Major renovations totaling approximately 175k were done in 2008. Unfortunately this work was not done by a contractor and I did my best to compile all receipts but for the sake of this discussion, let’s assume I have none. I married in 2009 and file jointly. In January 2011, the house was converted to a rental and we have not lived there since. We are considering a sale since we lived in the home for 2 of the last five years, however since it’s currently a rental will I still get the 500k exclusion or do we have to be currently living in it when it sells? We expect to sell for $440k. I’m so confused on everything I’m reading. I plan to meet with a CPA but thought maybe someone could shed some light. Thanks!

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Jeannette September 16, 2014 at 12:02 pm

Hey Joe,

I’m glad to hear that you’re going to meet with a CPA. In preparation for that, you may want to consult IRS Publications 523 and 527 (which deal with rental property and selling a home) to become familiar with the IRS rules and terminology.

The answer to your question is no, you do not have to be living in the home when you sell it to qualify for the capital gains tax exclusion. However, you do have to show that you lived in it for 24 full months during the five year period ending on the date of sale. By my calculations, you haven’t. Let’s say you sell the house on 9/30/14. The five year period that ends on that date began on 10/01/09. If you converted the property to rental use on 1/01/2011, then you would have only lived in the house for approximately 15 full months during that five year period. In that case, you would not meet the IRS’s use test.

And having or not having receipts for your renovations probably isn’t a factor in your case because the basis for determining gain on the sale of a rental property converted from personal use is generally the fair market value of the property on the date it was converted to rental use. But be sure to check all of that with the CPA. Good luck.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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mich September 11, 2014 at 11:20 am

My question is: we bought a duplex in 2011, lived in one side for 2 years and have had it rented out since then. The other side has always been rented out. we are looking at selling it now but there will be a 80K profit. how much in taxes are we looking at paying (percentage). I dont know if we would qualifiy for the 2/5 rule since it is a duplex. Thanks

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Jeannette September 16, 2014 at 11:13 am

Hi Mich,

I have some experience with duplexes because I own one. Because you lived in one side for a while, you will need to view it as two separate residences. Meaning, you should divide everything in half and apply the guidelines to each side separately. If you bought the duplex for say $200,000, you paid $100,000 for each unit. If you sell it for $300,000, you’ve sold each unit for $150,000.

That also means that you have to apply the IRS’ ownership and use tests (the 2 in 5 rules) to each side independently. If you didn’t occupy unit #1 for at least two years, then the entire gain on that unit would be subject to tax. If you occupied unit #2 for at least two of the preceding five years up to the date of sale, then you should qualify to exclude up to $500,000 (married filing jointly) of gain.

As for how much tax you might pay, that all depends on your marginal income tax bracket and your income level, and you didn’t say what those are. I’m not sure if the IRS is planning any changes to the tax law regarding capital gains for 2014, but as of now, if your marginal income tax bracket is 10 or 15%, the capital gains tax rate is 0%. But if your tax bracket is between 25 and 35%, then the capital gains tax rate is 15%. If your tax bracket is higher, ouch.

I recommend you consult IRS publications 523, 527 and 544 which all deal with income property and selling a home. Then make sure you consult a qualified tax accountant before closing the sale so you know exactly what you’re in for.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Karrey September 9, 2014 at 8:40 pm

HI, I bought a condo in 1994 for $144K. I got married 2005. Took equity out to purchase another condo. Current loan on condo is $350K ouch. It will sell for $400K. It’s been a rental for almost 10 years. We can’t do a 1031 exchange. Will we be taxed on approx $56K Our combined income is $120K. Yikes any recommendations? I don’t think we can get a buyer to do the installment payments.
Thank you
Karrey

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Jeannette September 12, 2014 at 10:34 am

Hello Karrey,

First, I don’t think you’re calculating your gain correctly. Gain on sale is “selling price minus selling expenses minus adjusted basis of the property.” If your selling price is $400K and we estimate your selling expenses at say $26K (6% commission plus other costs) and your adjusted basis at $144K (for lack of information), then your gain from the sale will be $230K. Bigger ouch!

If you haven’t actually sold the condo already, you may want to seriously consider doing as the author suggests and move back into it and occupy it as your main home for two years. It’s too bad that you can’t do a 1031 exchange. What about a deferred sales trust as described above? I don’t think you understand that it’s not the buyer who makes installment payments. From the little that I know about a DST, the buyer’s money is put into a trust fund that you establish and the trust then sends payments to you as you need the income. I suggest you visit with a tax or trust attorney who knows something about these.

Other than that, I recommend that you immediately make an estimated tax payment with the proceeds from the sale. Good luck.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Cathy Burkitt September 8, 2014 at 12:50 pm

I lived in the house for 3 years and the last year I am renting but now are thinking of selling. Do you know if I pay any capital gains?

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Jeannette September 12, 2014 at 10:05 am

Hi Cathy,

No, I don’t know if you will be subject to capital gains tax because you didn’t state what the adjusted basis of the property is and what you expect to be able to sell it for. What I can try to answer is whether or not you would meet the IRS’ guidelines for exclusion of any gain you might have from taxability.

If you do recognize a gain on the sale of the home, being able to exclude that gain from taxability will be based on the IRS’s qualifying tests. To claim the exclusion, you must have owned the home for at least 2 years during the 5-year period ending on the date of the sale of the home AND have lived in the house as your main home for at least 2 of those five years.

It would appear that you meet the ownership test because you indicated that you’ve owned the home for approximately four years now. And it would appear that you meet the use test because you indicated that you lived in the house for at least two of those years. So, subject to the actual dates of purchase, sale and when you first rented it, it would appear that you would be able to exclude up to $250,000 ($500,000 if married filing jointly) of gain from the sale from taxation.

I suggest you consult IRS Publication 523 for further details or arrange to meet with a qualified tax accountant in your area. Good luck.

(Please note: I am a California CPA. However, I don’t regularly do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Justina September 3, 2014 at 9:32 pm

Me and my husband own a single family house since 1991 but we place it in a family limited partnership in 2013. can we still get the tax exemption when we sell?

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Jeannette September 9, 2014 at 5:06 pm

Hi Justina,

I assume you’re referring to the tax exclusion on the sale of a primary residence. The answer to your question depends on quite a number of things. But primarily, are you living in the house or renting it out? How was the limited partnership structured?

I suggest that you sit down with a qualified tax accountant in your area so that you can fully understand the circumstances and get the best advice.

(Please note: I am a California CPA. However, I don’t do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Justin August 14, 2014 at 9:31 pm

Hello,

My wife and I purchased a home back in 2010 and lived in it for almost 3 years. We then bought a bigger house and rented out our first one. I am active duty and we are being transferred to another city and we are looking to sell both houses. will we have to pay any capital gains on either house? Also when I say my wife and I purchased the houses they are actually both in just my name.

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Jeannette August 19, 2014 at 9:29 am

Hi Justin,

There’s much more to say in your case than one can say in this type of forum; but here goes:

You only have to pay capital gains tax if you realize a gain when you sell a home. And even then, the IRS allows an exclusion on the sale of your primary or main home and a deferral on the sale of a rental property.

Will you realize a gain on the sale of either home? The formula to figure gain or loss on the sale of a home is:

Selling price – selling expenses = Amount realized – adjusted basis = Gain or loss

The IRS will allow you to exclude from tax up to $250,000 ($500,000 if married filing jointly) of the gain on the sale of your main home if you meet the requirements. In most cases, you must have owned and lived in the house as your main home for at least 2 years during the 5 year period ending on the date of sale. But you can only exclude gain once every two years. So you probably would not be able to exclude gain on both houses in the same year. IRS Publication 523 – Selling Your Home, provides more information on this subject.

With a home that you have rented, it’s a bit different. The IRS only allows a deferral of tax on the gain. So if you’re interested in that, the author discusses one method of deferral above: A like-kind exchange. To be a like-kind exchange, there must be an exchange of properties that are similar in nature and character even if they differ in grade or quality. But like-kind exchanges can be tricky, so it’s important to plan in advance.

I recommend that you consult a qualified tax accountant in your area very soon to help you plan for these events. Good luck.

(Please note: I am a California CPA. However, I don’t do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Saba August 11, 2014 at 8:09 am

Hi,

I purchased a townhouse as a primary residence in 2014. In 2009 I rented the property out because I was going to graduate school full time and not earning income. I’m finished with graduate school and I’m renting out a one bedroom apartment. I want to sell my townhouse because I can’t afford the mortgage and I don’t want to be a landlord anymore. My questions are:

Because this is my ONLY property I own, am I subject to capital gains?

If I must reinvest, does the home HAVE to be a rental? Or can I purchase a property and live in it as my primary residence?

Thanks!

Reply

Jeannette August 13, 2014 at 4:09 pm

Hi Saba,

First, paying capital gains tax is not dependent upon how many properties you own. You will be subject to capital gains tax on the sale of any asset (such as a home) if you realize a gain upon the disposal of the asset and cannot validly exclude it from taxability.

That being said, it sounds like you have owed the property for at least five years but have not lived in it for at least two years during that time (the dates you specified are a bit confusing). If that is the case, you will be subject to capital gains tax on the sale of the property if you realize a gain and you do not take steps to defer it.

The author mentions using a Section 1031 exchange as a way to defer tax on the capital gains. This is referred to as a Like-Kind Exchange. The IRS requires that there be an exchange of properties of the same nature or character, even if they differ in grade or quality. Also, the property you receive must be held by you for investment or use in a trade or business. However, there may be an acceptable time after which you could occupy the property as your primary residence and then when you sell it, you could be eligible to exclude the gain.

You may want to refer to IRS Publications 527 and 544 for further information on this subject. However, this can be a complicated issue so I strongly suggest that you find a qualified tax accountant in your area now and discuss your options. The accountant will be able to help you determine if you will realize a gain from the sale and how to orchestrate a 1031 exchange if you choose. You may also want to ask him or her about a deferred exchange. Good luck.

(Please note: I am a California CPA. However, I don’t do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Charley August 3, 2014 at 9:43 am

I purchased a home in 1980 and lived in it for a few years..for the past 25 years it has been a rental. Am I able to move back into it as my primary residence and after two years sell it and avoid the captial gains tax? I thought I had heard a few years ago that the 2 of 5 rule had gotten more restrictive.. maybe a calculation of how many total years owned vs how many years it was rented out during ownership? I am just a bit confused.

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Jeannette August 7, 2014 at 2:16 pm

Hi Charley,

I believe the answer to your question is yes (note: there is a maximum amount that can be excluded). Being able to exclude the gain on the sale of a home hinges on what occurred during the five year period ending on the date that you sell the home. For example, if you sell the home on September 30, 2016, the five year period in question would be October 1, 2011 to September 30, 2016.

The IRS requires that you have owned the home for at least two of the five years; and it sounds as though you meet that requirement. AND, you must have lived in it as your main home for at least two of the five years (I’m not sure if that’s any more restrictive than previous years). So, if you move into the house by October 1st of this year and occupy it as your main home, you will meet that requirement as well.

However, if you move in on October 1, 2014 but need to sell it prior to September 30, 2016, although you will not have lived in the house for the full two years, in most cases, you can still claim the exclusion; you just won’t be able to claim the maximum amount. You may want to consult IRS Publication 523 for additional information on this subject.

(Please note: I am a California CPA. However, I don’t do tax returns. You can read my blog at http://www.smallbushelp.com.)

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Steve P July 28, 2014 at 11:33 am

My wife lived in her mom’s town home for at least two years before her mom;s passing. We are currently in the process of renting the unit out until we deem fit to sell.

The house was not left in the will (the mom died intestate); but a qucik-claim deed was filed, and my wife is not responsible for the taxes and the mortgage. If we file taxes as jointly married couple, can we 1) claim and get back the interest paid every year in our returns, and 2) does my wife have to pay a (one time) capital gains tax while we she is renting it?

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Jeannette July 31, 2014 at 10:57 am

Boy Steve, you’ve got a lot going on there. Like, if your mother-in-law died intestate, who was appointed trustee of her estate? Has the estate been settled? Who legally owns the house now? If your wife isn’t responsible for the taxes and the mortgage payments, then who is? Who is responsible for filing your mother-in-laws final tax return? Did this happen in 2014 or prior?

In an attempt to answer your questions: 1) typically, you can deduct on your tax return (you don’t get it back per se) interest paid on a home mortgage that is secured by your main home or a second home THAT YOU OWN. If your wife isn’t responsible for paying the mortgage, then what interest are you paying that you want to claim on your tax return?

And 2) capital gains tax is only paid after a property is sold and only if you recognize a capital gain so no, there is no tax to be paid while it is being rented. But if you are collecting rent, you will have to declare that as income and pay tax on it.

You may want to consult IRS Publications 530, 535, 544 and 527 for more specific information. However, with all that’s going on, I very strongly suggest that you consult a tax accountant now and have a professional prepare your tax return for 2014; don’t try to do it yourself. Good luck.

(Please note: I am a California CPA however, I don’t do tax returns.)

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Peter July 15, 2014 at 1:36 pm

I have a rental property that I bought in 2011 that I would like to sell. I paid 400K and expect to sell at 750K. I also purchased two more rental properties this year for 140K each. Can I pay off the mortgage for the two new properties that I bought this year using the capital gains and will that count as equal transfer to avoid paying taxes on the capital gains?

Thanks,
Peter

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Jeannette July 21, 2014 at 9:00 am

Hi Peter,

Yes, you can pay off the mortgages on the two new properties with the proceeds from the sale of the 2011 property (actually, that would be a really great idea), but no, that won’t help you to defer paying taxes on the capital gain.

I believe what you’re asking is, “would this qualify as a 1031 exchange?” Because you have already purchased the two new properties, it won’t. The IRS has very specific guidelines regarding 1031 exchanges and most of the requirements have to be in place before you sell the existing property and before you buy any new property. Consult IRS publication 544 for further information.

But if you haven’t sold the 2011 property yet, maybe you can still orchestrate a 1031 exchange. I recommend you contact a qualified tax accountant in your area.

(Please note: I am a California CPA however, I don’t do tax returns.)

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Joe June 5, 2014 at 8:10 am

I retired from the military about 1 year ago and have been transferred many times since purchasing my home in 1993. The last time it was my primary residence was 2000-2003; it has been a rental since. I am now selling the property and would like to know what capital gain tax exclusions I may qualify for.

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Jeannette June 27, 2014 at 3:47 pm

You will want to consult IRS Publication 544 as well as Pub. 551 and probably Pub. 527. There may be others. Better yet, visit a qualified tax CPA in your area.

Right off the bat, the answer to your question as I see it is, “there aren’t any.” However, if you haven’t yet sold the place, consider orchestrating a Section 1031 Exchange (as discussed by the author) which will help you to defer any capital gains tax. If you’ve already sold the place, it’s too late.

If you can’t do a 1031 Exchange, the author also mentions a new tax deferral vehicle called a Deferred Sales Trust that might work for you. Consult a qualified tax attorney regarding a DST.

(Please note: I am a California CPA however, I don’t do tax returns.)

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Angie April 3, 2014 at 6:56 pm

I bought my home in 2007 for $550K. In May 2011, I moved and have rented for the last 3 years. I now plan to sell. The home value is approx. $450K. I have heard that we can not use the capital loss to offset other capital gains from other investments. What I have been told is that we must reset to the value of the house (at the time or rental) to approx. $350K. Do you know the answer to this or where I might go to find this?
Thank you. Angie

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Jeannette June 27, 2014 at 4:06 pm

Hi Angie,

You will want to consult IRS Publication 551 and Pub. 544. Better yet, visit with a qualified tax CPA in your area.

You appear to have two issues going on:

1. Capital gain or loss from the sale of a rental property off setting other capital gains or losses; and,
2. Establishing basis to determine if you have a gain or loss on the sale of your rental property

Number 2 first: Loosely stated, to determine the basis of the rental property (to determine gain or loss on the sale), you will start with the fair market value (FMV) on the date you converted it to rental use – instead of the price you paid for it or what it might be worth when you’re ready to sell it – then add the cost of any improvements that you made and subtract the amount of depreciation that you took. Pub. 551 will be your guide.

The issue of capital gains and losses can be rather complicated. Yes, some capital gains cannot offset capital losses and vice versa. But you don’t know if you have a capital loss on the sale of the property until you determine the property’s basis and then see what dollar amount you realize from the sale.

A local qualified tax CPA will be your best advisor.

(Please note: I am a California CPA however, I don’t do tax returns.)

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Leigh March 13, 2014 at 10:32 am

Recently purchased a home built in 1987. At the same time we purchased a piece of property in the same neighborhood. Will have lived in the house one year in July, but are considering building a new house on the property and renting out the older home. What length of time should we stay in the home before moving and what kind of tax hit will we take by moving out before 2 years.

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Jeannette June 27, 2014 at 4:21 pm

Hi Leigh,

You will want to consult IRS Publication 523 and Pub. 551. Better yet, visit with a qualified tax CPA in your area.

In 2013, the amount of gain on the sale of your primary residence that you could exclude from income was $250,000 ($500,000 on a joint return in most cases.) I’m not expecting that to change for 2014.

But in order to do that, you must have lived in the home for at least two years. If you move prior to two years, you will be taxed on the full amount of any realized gain. You’ll only know what that amount is after you’ve determined the homes basis and the amount that you realize from the sale. But you can probably estimate it at this point.

(Please note: I am a California CPA however, I don’t do tax returns.)

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Juli Mac March 11, 2014 at 5:11 am

I have heard the 2 out of 5 year rule has been discontinued or altered. Plus that depreciation resets the basis (calculated as if you had taken it even if you didn’t). With depreciation recapture 25%, plus cap gains, plus surcharge of 3.8% on investment income the tax load seems quite high. Plus my rental is in the worst zone for hurricanes/floods and flood insurance, already steep, will be going up 25% per year plus $250 PER YEAR. The rules were much more reasonable when I bought it and when I started renting it out (12 years ago). I couldn’t qualify for another mortgage now, too broke due to previous bad tenants x 2 and companies I worked for going out of business. Any advice please? Will I still owe a bundle if a hurricane destroys the house?

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Gwen Robinson February 16, 2014 at 4:59 pm

I bought a house in September of 2008 to live in myself. But it was tenant occupied at the time. Rather than kick them out, I let them stay there until the end of their lease in March of 2009, which is when I moved in. I lived there for a little over 2 years until June of 2011, when I got married and moved to my husband’s house. The old house has been rented out since then (for the last 2 year 8 months). If I sell that house now, am I exempt from paying capital gains tax since I have lived there 2 years out of the last 5? Someone told me that when you first start out renting a place out, the 2 out of last 5 years rule does not apply. Instead, you can only be exempt the percentage of time you had it as your primary residence out of the duration of the time you owned it. If this is true, this means only 2/5ths of the profit I make on the sale is tax exempt. Does this sound correct? But I did not buy this house as income property. I only let the old tenants live out their lease. Two accountants have given me conflicting answers to this question. Please advise!

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Daryl Meiser February 9, 2014 at 7:14 pm

I would like to sell my rental property and purchase a second home as my work is moving me to another state but I want to keep my primary residence. How does this affect capital gains tax?

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Steve Palmer February 9, 2014 at 8:57 am

I have been renting a room out of my main home that I have owned and always lived in. To offset rental income, I had been depreciating a portion of my home. I stopped renting the property at the end of February 2013. In May of 2013 I sold my home. I know I am eligible to exclude the gain on the sale of the house as I have lived in it from day 1. But my tax program wants to add back in ALL of the depreciation that I took since the day I started renting it as a long term capital gain. The Tax program also wants to use the total depreciated amount to lower the basis of the house. Seems like a double wammy to me. Is there a way to avoid paying capital gains on the depreciated amount in my situation?

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Jug Bedi January 30, 2014 at 3:17 pm

If I have lived in a primary residence for 26 years and then rent it out, can I still claim tax exemption when I sell it? If so within how much time I must sell it without loosing the tax exempt benefit

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Rachel June 12, 2014 at 7:07 pm

I purchased a town home in Calif in 1975 and lived there till 2009 and then rented it out til 2013. Can I deferr capital gain. Am I able to depreciate the property. Also in the years I lived there and made improvements can I deduct such to reduce my capital gains

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freida hernandez January 24, 2014 at 11:16 am

I bought a house in mt name over 2 yrs ago for my daughter and claimed it as rental property and took depreciation and upkeep off of my taxes for a 2 yr period. Am selling the house now and profit from original sales price will br 45k. Do I have to pay capitol gains tax…since I owned the property. For over 2 yrs. I did not live in the house?

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pryncesa January 22, 2014 at 7:55 am

Do I have to paid taxes in a investment property if only for the purpuse of the taxes I made figure that I live in one and I ‘m renting the other level?

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Patti Bodor December 22, 2013 at 9:55 pm

I recently sold my rental property for gain in September 2013. Can I still do a 1031 exchange by buying a fourth of ownership in another rental property? The value of the 1/4 ownership is higher than the total amount of the sold rental. I don’t have much time left to make this decision. Thanks very much in advance.

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alison chen October 25, 2013 at 5:20 pm

Hi, Jason:

We lived in a single family house from 2005-2011 June. From July 2011 we rent it out up to now. If we sell this house and close escrow before June 2014, do we need to pay the tax for capital gains?

Thank you for sharing so much information to us.

Alsion

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Fernando November 29, 2013 at 3:08 am

Alison,

I’m in the same boat as you are and was wondering if you’ve come up with any good information?

Fernando

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Tammy S October 20, 2013 at 10:04 pm

I bought my house in 1984 for 74,500. Raised my family and got it in the divorce in 2007. My daughter married and lived there and I bought a house in 2008 for over $250,000 20 miles away closer to work. Being a young family they needed a safe place to live and I hardly collected anything for rent from them in those 6 years. 50 Percent of fair market rental so my tax advisor indicated that because I was within $100 not to claim as rental property. In 2013 I sold the home she lived in her 26 years to her and husband for $135,000. Are there any allowances for home sale to immediate children for capital gains reductions?

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Susan schnitzer October 9, 2013 at 9:29 am

If we sell a single family rental property and purchase a multi family rental property, live in one unit, will we still qualify for section 1031 exchange?

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Jacqueline October 1, 2013 at 6:52 pm

I’m currently living in my Townhome because I took advantage of the Making Home Affordable Program offered by the Obama administration. I took cash out of it 8 years ago to buy another property in another country. My question is when I sell the Townhome here, do I pay capital gains on my original purchase price? Or do I pay it on my current mortgage payment which is 200,000 more than my purchase price, thus making my capital gain a lot lower. Example: I bought my Townhome for 369k and refi’d for 520k. When I sell for let’s say 750, is it capital gains tax starting from 369k or 520k? I’m also single.

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Jean Parke February 2, 2014 at 7:07 pm

capital gains are based on original purchase price + any capital improvements you have made to the home (additions, remodels, major improvements, etc.)

They have nothing to do with your mortgage amount.

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robert September 8, 2013 at 9:19 am

I am in the military and I bought my home in 2003, I lived the home until I received order to move 2007. It has been a rental since. It is now 2013 and I am considering selling the home. Do I meet any capital gains exclusion in this situation?

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robert September 8, 2013 at 9:14 am

I am in the military and I bought my home in 2003, lived in till I received order to move 2007. It is 2013 and I am considering selling the home. Do I meet any capital gains exclusion in this situation?

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JT August 21, 2013 at 2:31 pm

If I sell a rental property for a gain can I roll the gain to pay down the mortgage on my primary residence tax free?

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Bettye August 20, 2013 at 10:31 am

I have a Duplex in California and I live in one, but I am planning on selling it between 2014 to 2016. How can I keep more money for my retirement and pay less taxes? Thanks

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alex August 5, 2013 at 2:12 pm

just sold a rental property for gain
can I payoff existing mortgage on primary residence with this money and avoid tax liability in the process?

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Heidi July 7, 2013 at 8:05 pm

I have a question about inherited property that was and is rented. I want to sell it to make some of the money I received. It was valued at 86,000, but will sell for less. It has been only a few months (will be a year in Dec.) since I received the property, although it has been 3 years since the death. What do I need to do, what will I be hit with, and can I use the money to do additions to my personal home?

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Sherrie hicks July 7, 2013 at 2:27 pm

Hi,
We have owned a 1031 property for 7 years. It was purchased with funds from two other rental properties. We have 50% equity ($300,000 equity. $600,000 value) in the property and want to do some renovations ($60,000 in renovations) on the cabin.

Can we use our equity to do the renovations? If so, how do we access the money? Home equity loan? Stand alone loan?

How will this be taxed at the time of sale when we pay capital gains (no plans to sell the property).

Thank you for this resource!

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Crystal July 7, 2013 at 12:04 pm

I am currently selling a rental property. Can I convert my current primary residence (owned less than a year) to a rental and use the 1031 exchange if I buy a new primary residence?

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Peter Armour June 27, 2013 at 6:05 am

I have a rental property up for sale and I know I will pay Capitol Gains. I calculated Original Purchase price of $85,000 and selling for $115,000. $30,000 is my capitol gain but not sure if that is the tax I owe or is it a 15% tax on the $30,000.

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Amy September 9, 2013 at 5:04 pm

I am currently selling a rental property for gain.

Can I payoff existing mortgage on primary residence with this money and avoid tax liability in the process?I have had the rental home for 16 months. Please advise. ThANK YOU

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Peter June 20, 2013 at 5:22 pm

I moved out of my primary residence for a job out of state and eventually rented it but for less than my mortgage (its a loss for income purposes). I’m running up on the end of the 2 yr/5yr rule for the exemption. Although I’ll have capital gains by the Basis calculation, I won’t have much actual net gain when I sell. Other than selling the property now, is there a way to reduce capital gains if this is my only property and only significant investiment? I don’t plan on rolling any proceeds into a similar price house but probably lower price. And I don’t have opportunity to exchange as I don’t plan on being a landlord again. Thanks for any advice.

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Lucy June 6, 2013 at 8:08 am

If you have a cottage on your property (having lived in the main house for 27 years), now you want to move into the cottage and rent the main house.
How does the two out of five exclusion work? When you sell can you get your full exclusion or only a partial.

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karen May 26, 2013 at 6:37 pm

I have had a 4 unit multi family house where I’ve lived in the one unit for 13 years. I purchased another single family home that I was going to move into at that time, but then realized that I needed to rent out first to lessen my debt load so Ive rented that out for 3 years now. I’m currently selling the multi unit house that I’ve lived in for a very long time and will be moving into the other single family house that I’ve rented out so my question is……are there any capital gains tax exemptions for me having lived in the multi unit for so long…for my personal residence even tho 3/4ths was rental? I’m also learning that I may be paying a recapture on depreciation also of a hefty amount as well. Would the deferred sale trust be the way to go on this? Or do I just buck up and pay the piper? It would be nice to have some relief for this being my personal residence. What do you advise??

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jp June 4, 2013 at 7:24 am

Sounds like since you lived in the multi-unit dwelling 2 out of the last 5 years, the “status” of the property changes from Investment to Personal.

As such, the gain would be excluded up to $250,000 for single filer and $500K for joint.

The “essence” of the property is essentially Personal since you lived there 2 out of the last 5.

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Karen La point May 21, 2013 at 7:31 pm

My husband and I have dual primary residences. His job in Philadelphia, lives in our Downingtown, Pa, I was relocated to Tustin, Ca with my job and my daughter and i live in our Southern Ca home. We file jointed married. When we sell one of our home what happens with capital gains?

Please advise

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Kimberly Goodwater May 13, 2013 at 11:49 am

I was divorced a year ago and in my divorce papers it states that if my exhusband sells the property I am to get half. My question is did he find a loop hole in the paper work by renting the property out. If so what should I do?

Kimberly Goodwater

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Michelle April 26, 2013 at 5:33 pm

Hi Jason,

Thanks for the information–very helpful. I do have a question though. I have a rental house that I’m looking at moving back into (was my primary residence) after about 4 years of renting to satisfy the 2 of last 5 rule, then sell. I’m thinking of either selling my current residence (a condo) or renting it out for the couple of years while I live in my house, then basically sell both of them around the same time. I’m not interested in doing a 1031 exchange. I understand the last 2 out of 5 year rule, but read somewhere you can only do this on one property every 2 years. If I rent my condo would I then be subject to capital gains on it if I sell it in a couple of years, having lived here for three years prior? I guess my question is can I do this on both properties if I technically qualify for the 2 of last 5 year rule? Thanks!

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Tracy April 18, 2013 at 11:30 am

Hi. We built a house in 2005 and had to leave it due to job transfer. WE have rented it out since then, but at a loss every month! We just tried to keep it from going into foreclosure, but we continually lost money. WE now have someone interested in buying. Will we pay capital gains? I have all the receipts we paid to build the home (pre-rental income receipts) that total more than we are selling it for, but some of the receipts have faded. The person interested in purchasing is wanting to do a lease option and pay us money over three years to apply to the principal and wants us applying to our mortgage. Technically, that money is closing money, but if it is given two years or more before the closing do I have to count it as income now or just wait and count it when we do actually close?

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Debbie April 17, 2013 at 4:30 pm

I have a question about this gray area phrase that is used “The simplest way to avoid the capital gains tax, then, is to live in the home for at least two of the five years immediately preceding the sale.” What does that mean? Does that imply that you have to have lived in the home in the the IMMEDIATE two years before you sell it? We have owned the home for 15 years,and just starting renting it out. In a black in white answer, how long can we rent it without paying the capitol gains? We won’t have lived in it for the IMMEDIATE two years before the sale. But we will have lived in it for 2 of the 5 years that we owned it. Pls help with a simple answer that seems to have alot of gray area’s.

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Jason Van Steenwyk April 17, 2013 at 10:53 pm

Hello, Debbie, and thanks for writing! There are a couple of special situations where different rules apply, such as where the homeowner is active duty military. But for most folks, to qualify for the full capital gains exemption, you have to meet a two-pronged test, called the ‘ownership and use’ test. 1.) You have to have owned the home for two of the past five years, and 2.) You have to lived in the home for at least two of the five years immediately preceding the sale. There’s no requirement that it has to be the last two years. It can be any two years. Furthermore, you can’t have excluded the gain from the sale of another home in the previous two years. See http://www.irs.gov/publications/p523/ar02.html#en_US_2012_publink1000200713 All the best, and thanks for reading,

Jason

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Ruby April 15, 2013 at 6:23 pm

I’m almost past the two out of five year time-frame. If I sell to a friend at a very low price within time frame, and then later buy back from this friend, does the two out of five year time-frame start all over again?

In other words, if I miss this time=frame, then when I do sell, will I have to pay capital gains tax?
If my income is low, does that mean you do not have to pay capital gain tax? Thanks for your response

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Jason Van Steenwyk April 17, 2013 at 10:56 pm

Hello, Ruby…

Remember, there are two tests… you have to have lived in the home for two years of the last five, and you have to have owned the home for two of the past five years. The clock doesn’t ‘reset.’ The IRS looks at the five rolling years prior to the sale. Remember that you can’t exclude gains more than once every two years. Jason

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Aneil April 12, 2013 at 12:41 am

We bought a fourplex last year to live in and rent the others. In other words owner occupied. In the middle of the process we got a military order to move overseas for 3 years and we had to move after living there for 3 months.

We realized the property had gained some value and now we are planning on selling it. We intend to move back to this place when we go back to Washington. If I sell this house now, do I need to pay capital gains tax at 15 percent as a rental house? Or is there a military waiver?

Please email me your expert solution

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RANDY April 8, 2013 at 5:35 pm

I sold a rental and made 100k which I invested into another new rental property five years ago. If I sell my new rental and lose 50K do I owe any capital gains tax?

thanks,
Randy

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Regina March 22, 2013 at 10:34 pm

I am selling my rental property and buying another rental property that I would eventually like to live at. In order to not pay capital gains tax, how long must my new property be a rental before it becomes my primary residence ?

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Christine April 10, 2013 at 6:49 am

I have the same question. And using the 1031 helps but it limits the amount of time you have to find another property and we also have a lot of repair costs on the one we are selling that we would like to use some of the monies from the sale to pay for. Also what is the % to pay on capital gains? 5-15%. That is a big jump, I could do 5% but not the 15%.

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Debbie March 8, 2013 at 1:25 pm

I rented out my home for 7 years…. never lived there during the 7 years. Can I take the money and apply it to the mortgage of two rent houses I already have and not pay the capital gain tax?

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Jason Van Steenwyk March 8, 2013 at 5:20 pm

Hello, Debbie, and thanks for writing.

Doubtful. Under the Section 1031 like kind exchange rules, you have to EXCHANGE one rental property for another. Selling it and applying the proceeds to pay off homes you already own is not an exchange, just a sale.

To lower your capital gains tax, you can sell other assets that you’ve lost money on… thereby employing a “tax-loss harvesting” strategy (You can Google around on that term for more information) or simply execute a Section 1031 exchange. Or simply keep on renting and let your tenants pay the mortgages on the other two properties.

Have a great day!

Jason

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val martinez February 11, 2013 at 8:20 am

If a rental property is owned by 2 individual people, and 1 person has lived in the residence for 2 years out of the five preceding years PRIOR To the rental and 2 years out of the five preceding the sale of the property, is capital gains tax eliminated from both owners?

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Gabe February 25, 2013 at 1:40 pm

I have the same question.
And what if an owner has a renter while they are living there as their primary residence?
Anyone?

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Chuck vB December 4, 2012 at 4:04 pm

I have a house that was my primary for 15 years, but I had to move as I changed jobs. The problem was that the home is in Phoenix and the market has been (and still is so bad I had to rent the property. So now I’m past the two out of five year time-frame. But it was Job related. Will the IRS exemption on the 2 out of five year work in this case?

Thanks
Chuck

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mae pickens May 19, 2013 at 11:36 am

I’m in the same situation. Is there any forgivness from IRS do to job related transfer. Avoid paying the capital gain if I sale in Calif.. Otherwise, I’d have to move back into my rental in California for the next two years and rent my home in Nv.

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israel g. garcia November 13, 2012 at 10:21 am

bought new home how long can i rent old home without paying capital gains taxes

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CAROLYN B. KNOTT September 9, 2012 at 8:28 pm

I own a home that I’ve lived in for 16yrs; leaving due to the death of my husband and my own very serious health problems. I still own the home but I’ve rented it for a few weeks seasonally. Probably four weeks in 2012. I paid $226K. Now I can sell it for between $500K and $600K. I have done considerable work and repairs on the house in upkeep and preparation for either renting or selling – a new roof was installed 6yrs ago, I will have a sewer assessment of around $5K due – the realtor fees, painting throughout, carpet cleaning, etc. Where can I go for answers to my obligations? I am 82yrs old.

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Shannon O'Brien September 10, 2012 at 11:02 pm

Hi Carolyn,

It’s so nice to finally start hearing about homeowners with equity in their homes!

That said, I don’t understand what you’re looking for when you say “answers to my obligations.” If you can clarify that and let us know what questions you have we’d be happy to help.

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CAROLYN B. KNOTT September 11, 2012 at 3:06 pm

Shannon – 1. Do I still get the $250K credit, even though I have rented the house for a few weeks? I have not lived in the house for any part of the past 5yrs. Just a couple of months each year. It is impossible for me to move back to NC due to my declining health and inability to live alone. Many surgeries have left me with “foot drop” and neuropathy in my feet and legs. The continuing expenses make it financially tight, thus trying the rental route to help out.

We added a burglar alarm and boat life when we were building the house. We also added length and other amenities at a later date. I would guess about 5yrs after we moved in.

Do that answer your question? When you reply, please notify me at seaknott@gmail.com

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Jackson Lancaster April 2, 2012 at 9:13 am

People had better take advantage of all the tax benefits they can from their homes before they evaporate !

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