The tax consequences of selling or renting your home.

This report was prepared by Richard P. Krol, Certified Public Accountant. This information remains current as of January 2010.

Homeowners who want to relocate or move to larger or smaller quarters should determine whether it's in their best interest to sell their current residence. In making this decision, homeowners should consider the impact their decision will have on their tax bill and personal financial situation.


Why sell?


Selling a principal residence is an option for homeowners who need the equity in their current home for a down payment on a new one. Homeowners who realize profits on the sale of their primary residence may qualify for a special tax break that can help to put their next home within financial reach: The tax law creates 100% tax-free home sale profits for qualifying taxpayers who sell their homes.


This exclusion replaces the previous deferral-of-gain rule that required taxpayers to purchase a replacement home within certain time and price limits. It also replaces the once-in-a-lifetime exclusion of up to $125,000 of gain in a home sale for qualifying taxpayers age 55 and older.


The exclusion for home-sale profits


Under the current rules, a seller of any age, who has owned and used the home as a principal residence for at least two of the five years preceding the sale, may exclude from taxation up to $250,000 of profit, if single, and up to $500,000, if married filing jointly. Generally, the exclusion may be used only once every two years.


The law provides that married individuals may exclude up to $500,000 of profits if:

  • either spouse owned the home for at least two of the five years before the sale,
  • both spouses used the home as a principal residence for at least two of the five years before the sale, and
  • neither spouse is ineligible for the exclusion because of the once-every-two-year limit. If one spouse cannot use the exclusion because of the once-every-two-year rule, the other spouse may still claim the exclusion if he or she qualifies. However, the exclusion then cannot exceed $250,000.


Renting a home


A homeowner who puts his or here former principal residence on the market and then encounters difficulty in selling it, may be able to rent the residence for a temporary period and still defer gain on the sale. Planning can allow gain on the sale of a rental or vacation home to meet the requirements for the home sale exclusion. You can convert the property to your personal residence prior to the sale. If you meet the two-year ownership and occupancy requirement, some or all of the gain on the sale may qualify for the exclusion.


If you have picked out a new home but cannot or do not want to sell the old home just now, consider renting the old home. You can rent the old home for up to three years, and still qualify for the gain exclusion. The rental for three years, will mean that you used the house as a principal personal residence two of the past five years and any gain at the sale will be excludable (except for depreciation taken after May 6, 1997.) The rental period may allow you to get a better price in a slow seller's market, take advantage of an escalating real estate market, or change your mind and move back to the old house. For example, Sharon is moving from California to Oregon. The California real estate market is hot and she decides to rent out her old personal residence for a few years. The rental period allows her a chance to make some money from appreciation on the California house and still exclude gain at the subsequent sale because she will have lived in the California house two of the five years if she rents for less than three years. If she doesn't like Oregon, she still owns the California house and can return to it.


Converting a personal property to rental property



Tax deduction advantages when renting.



For some individuals, converting a former residence into a rental property may offer greater financial rewards. It gives owners the opportunity to generate steady income. What's more, although owners cannot defer the gain on the sale of a rental property, they are entitled to a wide range of tax deductions that can sharply reduce their tax bill. Mortgage interest, property taxes, and costs associated with operating and maintaining the rental property, including insurance premiums, repairs, and depreciation, may be deducted from rental income. Net losses (generally up to $25,000) can then be subtracted from the owner's gross income. Losses that cannot be deducted in the year incurred can be carried over into future tax years.


Even if you sell your rental property that does not qualify for any exclusions described above the profit is a capital gain, taxable like any other capital asset under the tax law. But there is one additional complication: the portion of the gain that represents prior depreciation is subject to special tax rules.


If you sell at a loss, the loss is considered "ordinary," which means you can deduct the entire amount, rather than being limited by the $3,000 annual capital loss limitation.



Important key tax benefits if you have lost equity.



The decision to convert a personal residence to a rental property is often made as a result of the homeowner's inability to sell the property at a gain or desire to retain the property for future personal use, as described above. In addition, if selling the residence would otherwise result in a nondeductible loss, consider converting the residence to rental property. This conversion may allow the homeowner to eventually recognize a tax deductible loss upon subsequent sale of the property. However, the property's basis for depreciation and subsequent loss on disposition is the lesser of adjusted tax basis or Fair Market Value at the time of conversion. Therefore, it is imperative to obtain and document the property's adjusted tax basis and Fair Market Value at the date of conversion. If the homeowner intends to incur major renovation or remodeling costs, these costs should be incurred after the property has been "placed into service" (i.e., offered for rent). This may allow for a higher depreciable basis of the property and turn repairs into deductions.


Since special tax rules apply in the year a property is converted to a rental and in the year of sale, an owner should consult with a tax professional, such as CPA, before making the conversion.



This report was prepared by Richard P. Krol, Certified Public Accountant.


If you have questions, want more details, or just want to talk about how the rules affect you, Mr. Krol is ready to help. Please give him a call at 800-CPA-KROL or email him.


Richard P. Krol, Certified Public Accountant
4055 East Thousand Oaks Blvd., #130
Westlake Village, CA 91362
(818) 889-9618 -- (805) 495-3763 -- (800) CPA-KROL
Fax (805) 494-6826