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Thursday, June 22, 2006

Tax Question - Converting Rental Property to Primary Residence?

I have been trying to understand the implications of renting all or part of my new property while I am on my temporary assignment. I will be away for the rest of the year and hope to rent out some portion of my house while I am gone to help offset some of my living expenses while on my temporary assignment.

I have some experience converting a previous primary residence to a rental property so I feel comfortable with the tax implications from converting all or a portion of the property to a rental property and handling maintenance, repairs, etc. However, I know nothing of the implication of turning a rental property back to a primary residence after my temporary assignment is over.

I have found no examples that give me any idea of the implication of converting a rental property to a primary residence. For example lets say I rent out 1/2 the house for 6 months and the deprecation for the entire property is $5,000 for this rental period. I should be able to write off $2,500 for deprecation from the rental income (1/2 of the $5,000). After the rental period I convert the entire house back to my primary residence.

-> What is the adjusted cost basis for the property? Is it [original cost basis] - $2,500 (the amount of deprecation I would claim on my taxes from the rental period)? Or is it [original cost basis] - $5,000 (the deprecation amount for the full property although only 1/2 was claimed on taxes because only 1/2 was rented)?

-> If at a later date I decide to convert the property [again] to a rental property, what are the implications? I assume the cost basis is adjusted downward by the amount I deprecated the property during the first rental period? Would deprecation continue while its my primary residence from when I first claimed it on my taxes during for the rental period?

-> When I sell the property is some deprecation that I must reclaim that I wasn't able to use to offset income on my income taxes?

Anyone with insight please advise - thanks!

32 Comments:

  • Do to the limited time you will be recieving income on your home, I would not depreciate this.

    I would run this like a separate income. Kind of like a self-employed venture. Meaning I would record the income and all expenses outside of the norm, that I receive.

    By norm I only mean taxes, mortgages, and insurance. If, while I was gone I paid the utilities, that would be a write off against my rental income.

    If you were to depreciate and treat it like a rental you would open yourself up to a lot more issues later. Like reclaiming the write-offs at the sale of said property.

    Why not do it where you can be done with it when the time is done. It is just another stream of income or side line.

    Oh, if you have to acquire extra or different insurance for the renter I would right that amount off against the income.

    By Blogger D, at 9:59 AM  

  • Good question - I thought I had read that the IRS's viewpoint is the deprecation happens regardless of whether you actually take it or not as a deduction on your income taxes. Therefore when I go to sell the property I must reclaim the deprecation even if I didn't take it on my taxes. If thats true then I might as well take advantage of it or it will be costing me......

    By Blogger 2million, at 10:33 AM  

  • :)

    By Blogger Smiley, at 12:48 PM  

  • Honestly, you should be consulting your tax advisor for your personal situation. That being say, my opinion (and this is just my opinion, not advice) is that if you rented out half of the house, you would just be able to claim depreciation on that half for whatever period of time it is rented. Just liked if you lived in one side of the duplex and rented the other out.

    So, in that case your cost basis after renting it out and then turning it back into your primary residence would be the cost - $2,500 + whatever capital improvements you make.

    As for the tax implications after it is turned back into the primary residence, basically you just keep track of the basis and no more depreciation would take place until it was re-rented. You would also be able to use the 250k exclusion on sale on the whole house after 2 years after you stop renting it (assuming you use it as your primary residence), though you will still have to recapture the depreciation taken (the exclusion doesn't cover that). Which is why renting sections of a house and home offices are a total pain in the @$$ to account for.

    Though if you are going to be renting it out in the future be sure you have all of the basis items documented in an easy to understand format. You'll want, the original cost divided by two (one portion that was rented and the other you lived in), the depreciation taken on that section that was rented and the cost of all improvements.

    By Anonymous Anonymous, at 12:25 AM  

  • I'm no tax pro but I understand that if you live in a property for 2 of the last 5 years and go to sell you don't have to pay Capital Gains. My friend's mom moved into a rental of hers for 2 years for this purpose.

    Another option is the
    Starker exchange or 1033 where you
    Sell Rental a property and buy one or more to value equal or greater value and no capital gains. You Must Identify the property(s) you will buy within 45 days and close within 180 days. And you have to work with an intermediary (~$1000).

    Let me know if I'm off but this. I'm not sure how depreciations taken figure into this.

    By Anonymous John, at 4:40 PM  

  • I actually did this with my old condo; I bought it, moved overseas and rented it out for a few years, moved back, lived in it for three years, and then bought a bigger place and rented it out for three more years before selling it. I sold it after renting it for three years and was able to regard it as a primary residence for cap-gains purposes.

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