Author Topic: Capital gains when we rent out main house but live in a garage apt on same lot?  (Read 1696 times)

Marvel2017

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My wife bought a house in 2009 before we were married. It was her primary residence. We got married in 2012 and lived in the house together until Dec. 2013. At that time we bought another house and moved. But we kept her house and rented it out. Dec. 2015 we built a garage apt on the lot of her original house for us to live in and moved back onto the property of her original house. So on the same lot there is the original main house that we still rent out to tenants and the garage apt that we have lived in since Dec. 2015. So my question is, if we sell the house in Jan of 2018 will we qualify for the capital gains exemption of living there for 2 years out of the last 5 years as primary residence? Or once we make money on renting the house does that totally go away? Thanks!

waltworks

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You'll have to pay capital gains, but not on the portion you actually occupy (the garage appt). You'll have to figure out how to assign a value to the apartment, but that's pretty easy to do.

-W

Marvel2017

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So would this be considered the same as a duplex? Essentially two pieces of property on one lot, one inhabited by myself and wife, the second as a rental?

So I need to come up with the value of the garage apt (would this just be based on total sales price/sq footage total between main house and garage, then apply this $/sqft to the square footage of just the garage apt?



lhamo

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If the anticipated capital gain is large, it might make sense tax-wise for you to let the lease run out on the current tenants, move back into the main house and rent the garage apartment, and then put the property on the market after you have lived in it together for another two years -- the two years residence out of the last five years of ownership is what tips the balance in terms of the 500k capital gains exclusion.   You may have to exclude the cap gains on the garage apartment, but that might also be partially excludable based on the time you used IT as your primary residence.

This is complicated (and potentially lucrative) enough that you should probably discuss it with a competent tax professional before making any decisions.

waltworks

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The exclusion is now pro-rated, so you could eliminate only 40% of the capital gains by living in the main house for 2 years.

The basic question of whether living on the property (in a tent, in the garage, whatever) while renting out the main house is enough to get you the exclusion is a big fat no, though.

This is worth spending a few bucks on a tax professional.

-W

Marvel2017

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Thank you. Yes, my wife owned the house since 2009. The renters moved in May 2013 and are moving out May 2017. So if we sell the house, we would calculate the % of the exclusion that we would get by taking the time occupied by us and divide by the total time owned. So the % that we actually lived in the house would be the % of the exclusion we would get, correct? So basically if total years of ownership is 9 and 5 of those years we lived there, we would get 5/9= 55% of the exclusion? So we are married filing jointly, so we would have ($500,000 X .55)= $275,000 of the gain excluded from capital gains? I will get a CPA, just wanted to run this by you guys first to get a little educated.

So (assuming tax law does not change), the longer we live in the house from here on out, the larger % of the exclusion from capital gains we'll get, right?
« Last Edit: April 18, 2017, 07:15:14 AM by utgrad »

lhamo

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No, it doesn't work that way.   The lookback period is 5 calendar years from the date of sale (typically calculated as the date of closing).  It doesn't matter that your wife owned it prior to that, or whether or not you lived in it prior to that.   Only the immediately prior five year period counts.

Marvel2017

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So if we live in it for the next 5 years after the tenants leave, we get the full exclusion? So the fact we did rent it for 4.5 gets "erased" because the IRS will only do a 5 year "lookback"?
« Last Edit: April 18, 2017, 08:56:20 AM by utgrad »

lhamo

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Yes, I believe that is the case.   As noted above, you are wise to consult a tax professional to be sure.

aj485

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So if we live in it for the next 5 years after the tenants leave, we get the full exclusion? So the fact we did rent it for 4.5 gets "erased" because the IRS will only do a 5 year "lookback"?

Not really.  You will still have to recapture the depreciation from the time the home was rented.  Plus, if you rent out the garage apartment during the 5 years, you are still renting out part of the property, so some of the gains would have to be allocated to that.  IRS Publication 523 has details https://www.irs.gov/pub/irs-pdf/p523.pdf  I would also suggest that you consult a tax professional, as your situation - starting with one unit on a piece of land as an owner occupant, then renting out the entire property, then building another unit on the same piece of land and moving back into it, then maybe moving back into the original unit and renting out the new unit, is complex enough that you want to be sure to have solid back up on what you are using for the basis of each part of the property for each time frame if the IRS questions it. 

In fact, I would recommend consulting a tax professional in the next couple of months, whether or not you decide to sell or move when your tenants move out.  At this point, you still have the opportunity to go back and amend your tax returns from 2014 - 2016 if it turns out that you have used an incorrect basis for depreciating the property.  If you wait until this time next year, you won't be able to amend your 2014 return.