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Conversion of residence to rental investment

Scott Wait

Many taxpayers are concerned about the tax consequences on the conversion of their personal residence to a rental investment.

This issue can be a major investment decision for people of many ages

and income levels.

If this is your concern, your issue relates to the IRS home sale exclusion rules (Section 121) and the like-kind exchange rules (Section 1031).

At this time, the IRS has only vague guidelines on how long your former residence must be rented to an unrelated party in order to convert it to a rental property and qualify for future like-kind exchange investment opportunities.

IRS code allows only swaps IRS rulings state that the conversion of your property to a rental must occur before a like-kind exchange is allowed.

IRS code section 1031 only allows real estate swaps of business or investment property for other business or investment property.

In other words, the IRS doesn’t allow a swap of your personal residence for a business or investment property.

The legal guidelines and court cases have clearly shown that your residence is considered a rental after you have moved out when claiming a capital gain/loss due to appreciated/ declined property value or when claiming tax deductions for operating expenses and depreciation.

You must show clear intent to make a profit on renting the property over an extended period of time, not just for a few months or to account for costs before an intended sale.

Listing the property for sale during rental periods will disqualify the conversion to a rental.

You need to have the property rented regularly and continuously with a profit intent.

It is also necessary to rent at market value rental rates to avoid IRS audit challenges.

The IRS hasn’t given guidelines on how long your former residence must be rented before it is considered converted into a rental property.

It is best to rent it for over 24 months to avoid an IRS challenge.

There is an IRS ruling that allowed a taxpayer to qualify a beach house in a swap for another home as an investment property (IRS Private Letter ruling- PLR8429039).

In this case the taxpayer had rented the beach house for over 24 months before swapping for the other rental.

Clear intent for profit Taking into account the noted ruling, the IRS would agree that a residence has been converted to a rental when you have shown clear intent for the property as a for-profit activity for at least two years.

Please note that if you also wish to receive the home sale exclusion $250,000 (single filers) or $500,000 (married filers) the former residence can’t be rented out for more than three years after moving out of the property.

Scott T.Wait is a CPA and a business management consultant practicing in Reno.

Your comments, questions and business inquiries are welcomed to RS Wait, Chtd., 6566 S.McCarran Blvd., Ste A, Reno, NV 89509, 825-7337.

E-mail Scott at scott@rswait.com or visit http://www.rswait.com


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