Capital Gains Tax on Rental Property Sale

[Landlady]

Wondering if anyone has experienced capital gains tax on selling their rental property and can give me some pointers or pitfalls to avoid. I own a triplex that has appreciated about $300k in the 8 years I've owned it. When I purchased it it was my primary residence. I moved out 3 years ago. Then I refinanced out of the ARM to lock in the low interest rates we're experiencing, but unfortunately I had to refi as an investment property because I bought another primary residence in the meantime.
When I bought the place I did do significant improvements, but didn't cost a lot because my husband and I did all the labor. We built a wall to make the duplex into the triplex it is now. We also did a lot of buff and puff work like paint, new tile, base boards, but I've read that this may be considered maintenance, not improvements.
Now we are considering selling the triplex within the next 5 years to realize the appreciation. Currently, we mostly hold real estate investments and I'd like to diversify.
1. I've read that if I have lived in the property 2 out of the last 5 years of ownership I can avoid capital gains. Should I sell right away considering I did live in the house until 2013?
2. I'm confused about claiming depreciation. How is this factored into the taxes?
3. How do I deduct improvements that are hard to count because they were my own labor and happened 8 years ago?

Sincere thanks to anyone that has pointers.

[Landlady]

I should state that I'm not for avoiding taxes, but by my calculations a capital gains tax would severely eat into my FIRE plans, so I'm looking to minimize the impact. I do like bridges and parks after all.

[waltworks]

You should consult an accountant for definitive answer but:
-You will probably have to pay capital gains on the sale at this point. As I understand it, the 2/5 rule is by the date you moved out/date you sold, not the calendar year of the moveout/sale. So if 3 years has already passed, you're beyond the limit.
-Depreciation that you took on the property will be recaptured on sale (barring use of a 1031 exchange) meaning that the amount you saved on your taxes (depends on the amount of depreciation and your tax bracket) will be due to the IRS.

If you want to use the proceeds to buy other rental properties, you can avoid both the capital gains and the depreciation recapture (for as long as you keep those properties) but if you want cash out of the deal, the IRS is going to get a big cut.

-W

[mathjak107]

all depreciation you took gets paid back too but it is capped at a max of 25% . even if you did not take it on a rental the rule is you will still have to pay it back .

1031 exchanges can be a minefield .  just look what happened when capital gains rates jumped to 24% from 15%  if they are high enough . the top rate went up to 20% and there is an almost 4% surcharge if you hit certain total income levels . anyone who kicked the can down the road got screwed .

be careful too with those exchanges . if you sell within 2 years of medicare age you can see premiums sky rocket .

also anyone planning to do this ,be careful making any vacation home or rental a primary . new tax rules apply and the 250k exclusion if single  or 500k exclusion if married gets prorated on anything bought from 2009 on . so if you owned it ten years , and for 5 years it was a rental or 2nd home and 5 years a primary , when you sell you only get half the exclusion

[rothwem]

Why not cash out Refi to realize the appreciation rather than sell?

You can then buy more properties and cashflow more. 

[mathjak107]

making loan payments to get access to money is not cashing out .all you are really doing is borrowing money . if the bank liked your face perhaps you wouldn't even need the property as collateral  .  in effect that is all you are doing , taking a loan like any other loan .

[Landlady]

Thank you everyone. You've given me some good points to consider as always.

[NoNonsenseLandlord]

Do a 1031 exchange to a house you want to live in.  Fix it up like you would want to live in it, and rent it for two years.  You do not even need to break even.

In two years, sell the house you live in, and take the capital gains, tax free.  Then move into the 1031 exchange house.

It's a win-win.

[mathjak107]

The above is not totally correct.

The tax laws changed in 2009 . Taking any property you previously owned that was not a primary and converting it gets prorated on the exclusion.

So if a property was owned 10 years and  a primary 5 years , if you sold you would only get half the 250k exclusion if  single or half the 500k exclusion if married.
Anytime a property was owned first as a rental or 2nd home it
gets prorated if it later becomes a primary.

[NoNonsenseLandlord]

The above is not totally correct.

The tax laws changed in 2009 . Taking any property you previously owned that was not a primary and converting it gets prorated on the exclusion.

So if a property was owned 10 years and  a primary 5 years , if you sold you would only get half the 250k exclusion if  single or half the 500k exclusion if married.
Anytime a property was owned first as a rental or 2nd home it
gets prorated if it later becomes a primary.

True.  The 1031 would be to buy a rental, then move in to it as your final home in retirement.  Any improvements would increase the basis r be a write-off.  It is a way to sell a rental and not pay capital gains.  Your heirs would get your home at the increased basis.

[mathjak107]

Not true in this case. Op has stated he wants to sell it , not keep it for heirs. Selling it makes what i said a negative if he 1031's it and makes it a rental first.