Converting A Rental to A Residence

Turning a Rented Property into a Home: Tax Considerations

Shifting from a landlord to an occupant of a property you own carries specific tax implications. If you’re considering making this change, here’s what you should know.

When you transition, the deductions you could claim as a landlord — including utilities, insurance, and maintenance — are no longer applicable. However, mortgage interest and property tax deductions remain available if your itemized deductions surpass the standard amount. Yet, these deductions could be constrained, based on loan size or if you’ve paid more than $10,000 in state and local taxes.

Moreover, you may still qualify for credits like those for eco-friendly upgrades or renewable energy installations.

The Complexities When You Sell

When selling the property now classified as your primary residence, you might be able to exclude some or all capital gains, depending on certain conditions.

No Deduction for Loss on Home Sale

Losses from selling a personal residence are non-deductible since they’re classified as non-business losses.

Qualifying for Tax-Free Capital Gains: Ownership and Residency Criteria

If you meet certain criteria, you could exclude up to $250,000 (single filer) or $500,000 (jointly filing) of capital gains from the sale of your primary residence. Generally, you can avail of this every two years.

You must satisfy two main criteria:

1. Ownership: You should have owned the property for a minimum of two years in the last five years before selling.
2. Residency: You must have occupied the house as your primary residence for at least two of the last five years prior to the sale.

The two years of occupancy and ownership need not overlap. For instance, you could have leased the property initially, lived there for two years, and then rented it out for another two years before selling.

If you’re married, either spouse can satisfy the ownership criterion, but both need to meet the residency requirement.

Limited Exclusions

If you don’t meet the above criteria, you may still be able to partially exclude gains due to work relocations, health issues, or unforeseen circumstances. IRS Publication 523 offers more details on these exceptions.

Post-2008 Rental Periods and Tax Impact

Since 2008, any time the property was used for non-residential purposes must be factored into the exclusion calculations. For example, if you bought the property after 2008, rented it for two years, and then made it your residence, the exclusion would be adjusted accordingly.

Recapturing Depreciation

After you transition from landlord to resident, any depreciation claimed during the rental period will need to be recaptured as ordinary income during the sale year, subject to a 25% cap.

Documenting Your Sale

The sale should be reported on Form 8949 if there is any non-excludable gain or if you receive a Form 1099-S.

If you’re thinking of switching a rental property into a personal home, we can assist in understanding the tax implications. Please reach out for more guidance.