Hi,

I have a tax related question on my rental home sale. Thanks very much in advance for your help.

I have lived in a house for 9 years. Two years ago bought another house and moved in. For past two years, I am renting out my old house. I am planning to sell the old house now to avoid the capital gain tax using the "living 2 out of 5 years" rule. My potential profit may be around $150K after expenses if the house gets sold. I already claimed depreciation on the house for last couple of years when it is being used as a rental property and filed taxes on the rental income. Please let me know my tax consequences if I sell the home now.
Here are my assumptions
- I pay taxes on the depreciation I claimed treating depreciation amount as a regular income.
- I do not pay any taxes on the $150K Profit since I lived for at least two out of 5 years.

Are these assumptions correct?

Also, another question. If home sale is delayed say for a year or so, do I have to pay capital gain tax on full $150K profit or will it be prorated based on how many months I lived in the house in last 5 years?

Is there anything else I can do to save on taxes?

I appreciate your response and thank you in advance.

I have lived in a house for 9 years. Two years ago bought another house and moved in. For past two years, I am renting out my old house. I am planning to sell the old house now to avoid the capital gain tax using the "living 2 out of 5 years" rule. My potential profit may be around $150K after expenses if the house gets sold. I already claimed depreciation on the house for last couple of years when it is being used as a rental property and filed taxes on the rental income. Please let me know my tax consequences if I sell the home now.
Here are my assumptions
- I pay taxes on the depreciation I claimed treating depreciation amount as a regular income.==>>>Correct it is is called sec 1250 depreciation recapture;aslongas your tax bracket is higher than 15%, you need to pay tax on it as ordinary income; The Taxpayer Relief Act of 1997 imposed a 25% capital gains tax rate for unrecaptured IRC Section 1250 gains.for example, let’s assume you purchase a rental property today for $100K. The total tax depreciation you plan to take over your estimated ownership period is $25K. You also project the property will be worth $140K when it is time to exit your investment. Your projected tax gain will be $65K($140K less $75K($100K cost less $25K depreciation)). Since your gain is greater than your accumulated tax depreciation, $25K,the recapture rule will apply. As a result, your tax on depre recapture is $3,750 ($25K x 15% if your tax bracket is 15%) and you can exclude $40K.however,
Aay, accumulated depreciation (otherwise subject to "unrecaptured section 1250 gain" treatment) is $25K, but analysis can reduce the gain attributable to the building at the date of sale to $10K, then the federal income tax to a high bracket taxpayer on the $3, 750 reduction is reduced from $3,750 to $1,500. The result is a $1,250 tax savings for simply be able to allocate more of the gain to land that is not subject to the recapture rather than the building.



- I do not pay any taxes on the $150K Profit since I lived for at least two out of 5 yearsAre these assumptions correct? .==>>Correct,but you still need to recapture your sec 1250 depreciation as ordinary income as mentioned in the example above.

Also, another question. If home sale is delayed say for a year or so, do I have to pay capital gain tax on full $150K profit or will it be prorated based on how many months I lived in the house in last 5 years?=======>>>>>>you need to be moving into it and making it your primary residence for ltcg exclusion on sale.
Potential tax pitfalls may arise from the rental of your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape taxation on up to $250K ($500K for certain married couples filing join returns) of gain on the sale of your home. However, this tax-free treatment is conditioned on your having used the residence as your personal residence for at least 2 of the 5 years preceding the sale. So, renting your home out for an extended time could jeopardize a big tax break. AS said, even if you don't rent out your home so long as to jeopardize your principal residence exclusion, the tax break you would have gotten on the sale will not apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997.
Is there anything else I can do to save on taxes?
=====>>>>>>
In the past several years, savvy Taxpayers have been using both tax code sections together by selling and buying a rental (instead of converting it back to primary home) through a 1031 tax-deferred exchange, later converting the replacement property rental house into a principal residence, and then later, selling the house and excluding all of the gain under IRC Section 121. Obviously the Treasury Department has perceived this tax planning strategy as a loophole, and therefore a provision to restrict this practice was recently passed into law.

Under the new provision, a Taxpayer who exchanges into a rental house under IRC Section 1031 and then later converts the replacement property into a principal residence, is not allowed to exclude gain under the principal residence exclusion rules of IRC 121 unless the sale occurs at least five years from the date of its acquisition through the exchange.

The provisions for the new law are effective for personal residence sales occurring on or after October 22, 2004, so Taxpayers who previously acquired their current residence through a tax-deferred exchange within the past three years will now have to wait at least another two years before selling the home and excluding gain under IRC Section 121, assuming the Taxpayer meets the two out of five year occupancy test. For example, Taxpayers who are now living in a house they acquired through an exchange two years ago will now have to wait another three years before selling the house under IRC Section 121.

ALSO NOTE;

Your home sale exclusion applies only to “qualified use” of a residence. “Nonqualified use” includes any period after December 31, 2008, in which the home is not used as a principal residence. Thus, if you stop using the home as your main home and use it only as vacation property, or if you rent it out, gain related to this period does not qualify for the home sale exclusion. Temporary absences are not treated as nonqualified use; they’re disregarded.so Gain from the sale of a home may need to be allocated between what gain be excluded and what gain is not excluded. The portion of capital gains that cannot be excluded is determined by the following ratio: Period of non-qualifying use divided by Period of ownership; for example say,
During the five years that you owned the home, there were two years of non-qualifying use when the property was not yourprimary residence. There were three years of qualifying use when you lived there as her primary residence. The ratio of non-qualifying use is 2 / 5, or 40%. Forty percent of the gain will be taxable capital gains, and the remaining 60% can be excluded from capital gains, up to the exclusion limit of $250K (or $500K for married couples filing a joint return).

Potential tax pitfalls may arise from the rental of your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit.