Rental and capital gains when selling

[dragonwalker]

I live in CA, single, and bought a 2 B 2 B condo last year for $375K. I have rented the 1 room and bath of the condo ever since and live in the other bedroom. Suppose I sell the condo in 5 years. How would the capital gains exemption work in this situation because I have heard different things. Do I only get the benefit of of $125K? Is it some proportion? 

[waltworks]

Are you depreciating the rental portion of the property?

-W

[dragonwalker]

I imagine I would be and although I have to confirm this I believe I would essentially be depreciating half the improvements upon the land.

[neophyte]

Curious to hear more about this. I've been renting out part of my house for a couple years now and SO is on the job market. We may have a move in our future.  I doubt I'd want to convert my house to a rental if I moved out of town. It'd be too much work for the money.

I have been depreciating the rental portion of the home.

[Sibley]

Depreciation recapture. Basically, whatever depreciation you took gets added to the sale price, from which you subtract your basis to get gain/loss. So yeah, you'll likely pay capital gain tax. There's an IRS publication that covers this, I think it's part of the sale of home one. I'm hiring out parent's taxes this year because while I can do the math I'm not competent to do the tax forms.

[dragonwalker]

Ok, thank you for the response but my question was more about the effect if any on my capital gains exemption as a result of renting my home. The conflicting information is on the one hand I am hearing that my exemption is cut in half in my case because I am renting essentially half my place but then I also hear that I still get the full exemption. Where can I read more about this or does someone know for sure. I tried calling the IRS and the few times I tried the phone options just directs me to a machine says that operators are no longer answering that extension. I don't know what IRS publication this information could be found in.

[bacchi]

You should probably ask a professional but the rental ratio applies to the capital gains and not to the exclusion. In other words, if your nonqualified use is 50%, and your gains are $600k, you'd get the full exclusion since .5 * $600k > $250k.

To put it another way,
Sale price - (cost+improvement) = gain
gain * nonqualified use ratio = taxable gain due to being a rental

The other half of the NQR, which is the same in this example, can be excluded but is of course maxed out at $250k.

Therefore, if you sold at $975k,
$975k - $375k = $600k gain
$600k * 1/2 = $300k taxable gain

That leaves $300k where $250k is excluded and the remainder, $50k, also becomes taxable.

IRS Section 121 describes the exclusion and Pub 523 describes how it works. https://www.irs.gov/publications/p523


Edit: Renting out 1 bedroom of a 2 bedroom is unlikely to be 50% personal use affect gains calculations. See Pub 523 exception "Space within the living area".

[dragonwalker]

I see, yes that's different than I understand it but makes things worse as I don't see selling my unit for 975K from a sales price of just 375K. What is more likely in the somewhat near future is selling at say 500K. It sounds like in this example I would owe .5 x 125K (my gain)? If I stop renting than to get the normal 250K does it go back to me needing to live there 2 of the last 5 years?

[bacchi]

Living alone would adjust the nonqualified use ratio, to your benefit, but you'd never get to 100% of the gains.

Edit2: See Pub 523 "Space within the living area."


If you're at 50% qualified use* at 6 years ownership, you'd be 3/6. Living alone from this point on would mean 4/7, then 5/8, then 6/9, then 7/10, etc.

There are some special rules with converting a rental to a primary but it may not apply to a rented room. It's been a while since I delved into that minutiae.


* Edit: And you're probably not at 50% if it's only 1 bedroom of the condo. See below for the comments about Pub 527.

[SeattleCPA]

One other thing to add to this discussion.

The gain isn't really long term capital gain.

The depreciation recapture is something called unrecaptured Section 1250 gain and taxed at 25% or your marginal ordinary rate if that's lower.

And then the other gain is regular old Section 1231 which is taxed usually like LT capital gains... but not always.

A minor point to remember...

[bacchi]

Clarification:

Pub 527 offers this,

Example. You rent a room in your house. The room is 12 × 15 feet, or 180 square feet. Your entire house has 1,800 square feet of floor space. You can deduct as a rental expense 10% of any expense that must be divided between rental use and personal use. If your heating bill for the year for the entire house was $600, $60 ($600 × 0.10) is a rental expense. The balance, $540, is a personal expense that you can’t deduct.

(bolded)

Personally, I'd follow the same rules for depreciation and exclusion.

Again, though, it's probably worth it to hire a professional for a few hours to run through some scenarios. Renting half of a duplex is pretty clear but renting a room is murkier.

I'll amend my previous posts to reflect this. @dragonwalker

[mswhitac]

Maybe a slight hijack but very similar, if you own a rental home, decide to live in for ~5 years as a permanent residence, after it was a rental home for 2 years, can you avoid the capital gains tax?  I would have depreciation that I have claimed during those 2 years.  Appreciate any further thought.

Kind regards

[LightStache]

Sorry @dragonwalker but you're getting some bad info. on this thread. You should disregard it and get opinions elsewhere.

[bacchi]

Sorry @dragonwalker but you're getting some bad info. on this thread. You should disregard it and get opinions elsewhere.

Do you want to explain why? Is it because a room rental doesn't affect the cap gains exclusion, even though it has to be depreciated?

Pub 523 has this:

Exceptions. The following situations apply when using only a portion of the main home for business or rental usage and don’t affect your gain or loss calculations.

     Space within the living area. If the space you used for business or rental purposes was within the living area of the home, then your usage doesn't affect your gain or loss calculations

Per that exception, the OP doesn't have to worry about gains taxes at all (beyond recapture).

As mentioned, using a professional for these calculations would cost a few $100 and is well worth it when working with $100k+ gains.

Maybe a slight hijack but very similar, if you own a rental home, decide to live in for ~5 years as a permanent residence, after it was a rental home for 2 years, can you avoid the capital gains tax?  I would have depreciation that I have claimed during those 2 years.  Appreciate any further thought.

Kind regards

@mswhitac You'd need to use the non-qualified use/qualified use ratio.

Gain from the sale or exchange of your main home isn’t excludable from income if it is allocable to periods of non-qualified use. Non-qualified use means any period after 2008 where neither you nor your spouse (or your former spouse) used the property as your main home, with certain exceptions (see next).

If you don't qualify for the exceptions, you'd be able to exclude 5/7 of the gain.