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Financial Information for Senior Military Officers

Movin' Back Into Your Rental? Hold on There Partner!

Movin' Back Into Your Rental?  Hold on There Partner!
I think most home owners are aware of the 2 out of 5 rule when it comes to selling your primary residence.  For those who aren't, the rule basically states that if you lived in your house for 2 of the last 5 years (there is an extension for active duty military) you can exclude $500,000/$250,000 (Married/Single) of Capital Gains from your income.  That means no taxes. 

When you look at that you might get the idea that you can move back into your rental house for two years and sell it and not pay taxes.  You'd be wrong on two accounts. 

First of all, you have to pay taxes on any "depreciation recapture" (not the topic of today's article).  You also have to pay taxes on gains attributed to "nonqualified use".

So, what is nonqualified use?  Here is what the IRS says:

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Delay, Deny, Deflect...

Delay, Deny, Deflect...
O.k.  This article is only going to talk about delaying...taxes and in a pretty specific case.  If you own a rental property, you've enjoyed some pretty good tax benefits.  For instance, you've been able to write off interest, repairs and any management fees.  But perhaps the best deal is the ability to write off get to take a deduction without spending any money.  Yup.  It's great.  Right up to the point when you sell the house.  Then the IRS says, "Since the house is actually worth more than what you told us (via depreciation) we want that deduction back."  And while you can't eliminate that tax bill, you can delay it.  If you're willing to buy another rental property you can delay the tax bill through what is called a 1031 exchange.  In a 1031 exchange you "exchange" your property for a like-kind property and any taxes are deferred.  But like anything with the IRS, there are pretty specific rules.
  1. First, the exchange must be "like-kind". In real estate transactions you have some latitude.  Basically, as long as the new real estate is similar it is considered a like-kind.  As an example, a rental house to apartment building would be like-kind.
  2. Second.  You can't put your hands on the money.  The proceeds of the sale of your rental house must go to a Qualified Intermediary (QI) and in fact, the QI must be listed on the closing documents.
  3. Next, you must identify up to 3 replacement properties within 45 days of closing on the sale of your current rental property.
  4. Finally, you must close on the new rental property (from one of the 3 above) within 180 days of closing on the sale of your current rental property.

Goof any of these up and the sale is fully taxable.  And, no, the IRS isn't likely to give you a "mulligan".


There are a couple of other things too.

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