Over the years, many clients have asked me if they could convert an investment property or rental home into a personal residence. The answer is yes, if you follow the guidelines.
Let me start by clarifying that I am not a tax advisor, but a real estate broker. Do not take this information as advice and buy the house of your dreams. Speak to your tax accountant and a 1031 tax-deferred exchange intermediary who can guide you through a transaction and inform you of the tax consequences.
If you own an investment property, you could sell it, take the money and later buy your new home, but you will pay taxes. You will most likely end up paying capital gains tax, recapture of depreciation and possibly the 3.8% investment tax.
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If your investment property is a single-family home, you can move in and change utilities into your name, using the property’s address for all your mail.
The converted property would no longer be reported on your Schedule E 1040 (or via a K-1 for a flow-through entity), but on your Schedule A. Your Schedule A is where you report your property tax and tax deductions. mortgage interest.
Your mortgage lender may have problems if you change the use of the property or the title of an entity to your name. Likewise, the county tax assessor will review the transfer of title.
If title is in an entity and it is changed to individuals, those individuals must be the same owners of the entity. If they are not identical, you may have to pay transfer tax.
You could make a 1031 exchange
If you own a small strip mall, for example, you can do a 1031 tax-deferred exchange in a single-family home that you rent to a tenant.
To meet the requirements of a 1031 tax-deferred exchange, the replacement property must be used for investment purposes to qualify as a “like-kind” exchange. “Like-kind” is more about tax status (investment or personal) than ownership type.
Your original intention of the exchange must be for investment purposes. You intend to rent the house at market price to a third party. There is no specific time to lease the property, but I understand that a minimum of two years is safe.
You exchange an apartment building for the house of your dreams; moving in soon after is a fraud. Or, keeping the house vacant for 18 months, never attempting to market rent, find a tenant or show income will undoubtedly be a red flag with the tax authorities.
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You should have documentation of your intent to rent the house, including emails to your accountant and intermediary. Having a lease and showing investment income will solidify your intentions.
Sending emails to your broker, accountant or intermediary indicating your intentions to move the day after closing will no doubt reinforce your intentions as well. However, it is legal to later choose to update your intentions and move into the house, but be sure to document a legitimate reason.
You can save taxes by strategically moving into a rental home you own or trading into your dream home; be sure to follow the guidelines and schedule when doing so.
Keep in mind that if you had a prior exchange, you could end up paying taxes from that event when you or your estate sells the replacement home.