Turn the investment property into your primary residence. Example: Jane buys a home on January 1, 2009 for $400,000, and uses it as rental property for two years. When selling your converted rental property, you lose the home sale exclusion. The two years don't have to be consecutive. In recent years Congress amended Section 121 in order to limit the benefits of Section 121 when the property has also been used as a rental. Provided they lived in the home as their primary residence for at least two years, they could sell it and exclude the gain under Section 121 up to the maximum level of $250,000/$500,000. Now you can do a 1031 exchange and defer all of the capital gains from a sale of that property. Can I sell the rental property and use the proceeds to pay off the mortgage on my primary residence without paying capital gains tax? When you sell an investment property, you will be subject to a capital gains tax. If you sell a depreciable property through a 1031 exchange, special depreciation recapture rules can apply. You can’t live in your house at all while it’s a rental property, and you must actually rent it out for some period of time. If you convert your rental home into your primary residence, you can avoid capital gains taxes, but it’s not a quick fix. Turning Your Rental Property Into A Primary Residence If you convert your rental property to your primary residence, and if you live there for two out of five years, you can exclude up to $250,000 in profit from capital gains tax if you sell the property. On January 1, 2011, she evicts her tenants and moves into the house, thereby converting it to her principal residence. Turn your primary residence into a rental. Another way to manage a 1031 exchange on a personal residence is to do the reverse of the previously explained situation. In this case, the selling price, selling expenses, basis, and the allowable Section 121 exclusion must be apportioned between the home itself and the business or rental … All right, so you’ve established that your property is no longer your primary residence, but a rental property. (This is the new S corporation you will create when you finish reading this article.) If your home has appreciated in value since you bought it, you can get both some tax-free income using the $250,000/$500,000 exclusion and a step-up in your depreciation basis by selling your home to your S corporation. If you sell your stocks or bond and buy a property residence, the IRS will not let you do a 1031 exchange (a properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes). For example, the property sold is a farm, and the farmhouse meets both the ownership test and the use test, but the barn does not meet the use test. You will have to report the Capital gain - to qualify for a residential deduction you have to reside in your home for 2 years out of the last 5. She then sells the property for $700,000 on January 1, 2014. On January 1, 2013, she moves out and rents it again. If you’re married, this exclusion increases to $500,000. For more information, check out our in-depth guide to 1031 exchange rules in real estate. The first residence can then be converted to a rental property. You Can Also Convert A Rental Property To A Primary Residence – Using A 1031 Exchange. There are tax benefits for selling a primary residence that won't be available on a long-term rental property. 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