Dear Liz: My husband and I have owned a rental property for 20 years. We’ve never lived in it. Now, we want to get out of the landlord business. We know we’ll have to recapture depreciation, but we always thought we could live in the property for a couple of years to save some on the capital gains taxes. Our accountant has told us that this is no longer true and we cannot save much by living in our rental. Federal and state taxes will take most of our profit. Is this true?
Answer: Congress dramatically shrank the loophole that once allowed people to reduce or eliminate capital gains on rental and vacation properties.
When selling a primary residence, homeowners can shelter up to $250,000 of home sale proceeds, or $500,000 for married couples, from capital gains tax if they’ve owned and lived in the home at least two of the previous five years. Those rules were established in the Taxpayer Relief Act of 1997.
Before the Housing Assistance Tax Act of 2008, landlords could move into their rentals for a couple of years, sell the properties and then invoke the home sale exclusion as if the property had been their primary residence all along.
Today most if not all of the gain on your property is considered “non-qualified use.” Only the appreciation you experienced before 2009, and after you move in, would qualify for the exemption.
The benefits of moving into a rental for a couple of years can vary greatly, depending on the specifics of your situation. Your tax pro can walk you through the math and advise you about some of your other tax-saving options, such as a 1031 exchange for another rental property or holding the real estate until death, when your heirs would benefit from a valuable step-up in basis. If you’re done with being a landlord, though, the cleanest solution might be to simply sell and pay the tax.
