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mowmowme
Level 3

Buying 2nd property before selling first home

Hello! I am looking to purchase a 2nd home and renting out my 1st home. If I cannot handle being a landlord and sell the 1st property AFTER buying 2nd home, will I end up paying capital gains tax since I didn't technically use the money to purchase 2nd home, or does it count that I use the money to pay down the 2nd property's loan? These properties are all within NJ. Thanks in advance!

1 Best answer

Accepted Solutions
Opus 17
Level 15

Buying 2nd property before selling first home

1. As stated, the sale and the purchase are unrelated, how you spend the money from one does not change the tax on the other.

 

2. You can't do a 1031 exchange to postpone the tax on the sale or purchase of a personal home.

 

3.  If you sell home #1 within 3 years, you can still use the personal exclusion of gain on sale of your home.  To use the exclusion, you must have owned the home at least 2 years, and lived in it as your main home for at least 2 year (730 days) out of the 5 years immediately prior to the closing date.

 

The exclusion is $250,000 or $500,000 if married filing jointly.  So if you sell home #1 in exactly 3 years or less from moving out, you can exclude tax on the first $250,000 of gain, the rest is taxable.  (You will also pay depreciation recapture tax on the depreciation you took or could have taken on the home while it was a rental.)

 

If you miss the 3 year window by even one day, then all the capital gains from sale of home #1 will be taxable. So you will have to have a conversation with yourself around the 2 year mark, is renting profitable enough that you are willing to rent long term and forego the capital gains exclusion, or would you rather sell while you still have the exclusion, and invest the money somewhere else.

 

You may also want to have your lease contract reviewed by a real estate agent or attorney to make sure there is nothing in the contract that would get in the way of selling the home if you decide to put it on the market while you have a tenant.  

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

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11 Replies
mowmowme
Level 3

Buying 2nd property before selling first home

 
xmasbaby0
Level 15

Buying 2nd property before selling first home

What you do with the proceeds of selling your first home has been irrelevant since 1997.   Avoiding capital gains by purchasing another home was removed from the tax code in 1997.

 

SALE OF HOUSE

 

If your gain was more than  $250,000 filing Single, or more than $500,000 filing Married Filing Jointly the sale must be reported on your tax return.  Whether you re-invested the gain in to another house is irrelevant.  If you  have a Form 1099-S go to Federal>Wages and Income>Less Common Income>Sale of Home (gain or loss)

If you owned and lived in the home as your primary residence for at least 2 of the last 5 years on the date of the sale, you do not have to report the home sale if the gain is less than $250K filing Single, or less than $500K filing Married Filing Jointly (and you both owned and lived in the home for at least 2 years).

**Disclaimer: Every effort has been made to offer the most correct information possible. The poster disclaims any legal responsibility for the accuracy of the information that is contained in this post.**
mowmowme
Level 3

Buying 2nd property before selling first home

Thanks for the reply!

Isn’t there something called the 1031 exchange? If the property becomes a rental, and I sell and purchase a new similar property, tax doesn’t apply. Essentially down the line when I sell and do not purchase anything new again is when I do owe taxes? 

Mike9241
Level 15

Buying 2nd property before selling first home

a 1031 exchange is possible as the tax laws now stand.  I say this because at one time 1031 applies to property other than rental real estate then the law was changed in 2018 eliminating 1031for everything but real estate used in business or held for investment.  while it's probably unlikely 1031 would be totally eliminated it can't be ruled out. 1031 is not as simple as just selling one property and buying another.  there are multiple rules that must be followed. mess up on just one and then you can have a fully taxable sale. also, you lose out on the home sale exclusion if the property sold would otherwise have qualified.

 

mowmowme
Level 3

Buying 2nd property before selling first home

Thank you! Very helpful!

rjs
Level 15
Level 15

Buying 2nd property before selling first home


@mowmowme wrote:

Isn’t there something called the 1031 exchange? If the property becomes a rental, and I sell and purchase a new similar property, tax doesn’t apply. 


Are you saying that you would treat the sale of the rental property as a 1031 exchange for your new home? You can't do that. You can't do a 1031 exchange for your personal residence, only for business or investment property. You could exchange one rental property for a different rental property, but not for your personal home.

 

Opus 17
Level 15

Buying 2nd property before selling first home

1. As stated, the sale and the purchase are unrelated, how you spend the money from one does not change the tax on the other.

 

2. You can't do a 1031 exchange to postpone the tax on the sale or purchase of a personal home.

 

3.  If you sell home #1 within 3 years, you can still use the personal exclusion of gain on sale of your home.  To use the exclusion, you must have owned the home at least 2 years, and lived in it as your main home for at least 2 year (730 days) out of the 5 years immediately prior to the closing date.

 

The exclusion is $250,000 or $500,000 if married filing jointly.  So if you sell home #1 in exactly 3 years or less from moving out, you can exclude tax on the first $250,000 of gain, the rest is taxable.  (You will also pay depreciation recapture tax on the depreciation you took or could have taken on the home while it was a rental.)

 

If you miss the 3 year window by even one day, then all the capital gains from sale of home #1 will be taxable. So you will have to have a conversation with yourself around the 2 year mark, is renting profitable enough that you are willing to rent long term and forego the capital gains exclusion, or would you rather sell while you still have the exclusion, and invest the money somewhere else.

 

You may also want to have your lease contract reviewed by a real estate agent or attorney to make sure there is nothing in the contract that would get in the way of selling the home if you decide to put it on the market while you have a tenant.  

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

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mowmowme
Level 3

Buying 2nd property before selling first home

@rjs thanks for the comment! 

My thoughts were to buy 2nd home to move into and i would rent out my current. if i want to sell a few years down the line, then technically I'd be selling a rental property?

mowmowme
Level 3

Buying 2nd property before selling first home

@Opus 17 Absolutely appreciate your detailed reply! Thank you!

 

1. Correct, i understand that part

 

2. I'm thinking because I plan to rent it out, it no longer is a personal home? but i do see your points below are much more to consider...! thank you!

 

Especially: (If you miss the 3 year window by even one day, then all the capital gains from sale of home #1 will be taxable. So you will have to have a conversation with yourself around the 2 year mark, is renting profitable enough that you are willing to rent long term and forego the capital gains exclusion, or would you rather sell while you still have the exclusion, and invest the money somewhere else.)

 

This is essentially the struggle I am having! Is it that after the 3 year window that I am not living in Home #1, it officially becomes an income property? I do plan to move back in around the 2-3 year mark, and thats why the hassle.

Basically, some major construction will be going on the next 2-3 years. Because I am home often, this will impact my life a great deal. Home #1 is in a prime city location, and would be easily rentable despite the construction situation. During this time, I plan to purchase Home #2 to live in until the construction is completed and I am able to move back. I then will rent out Home #2.

 

I am just concerned about possibly losing interest of moving back altogether (I hate moving!), and abort that plan, and just sell Home #1. This is why i am considering if my best bet is to sell and buy, or keep and buy.

 

Thank you again!

Opus 17
Level 15

Buying 2nd property before selling first home

@mowmowme 

As soon as you list the property as a rental, it becomes a rental property as far as the taxes are concerned. You report your income and deduct your expenses on schedule E.  However, because of the capital gains exclusion rule, you are still allowed to use the exclusion on the sale of your personal home even if you have temporarily converted it to a rental, as long as you are only out of the home three years or less.

 

To use the capital gains exclusion on the sale of a personal home, you must have lived in a home for at least 730 days or two years out of the five years prior to the sale. The 730 days do not have to be consecutive. For example, if you moved out of the home for three years, and then moved back in the home for one year before you sold it, you would still meet the 2 years out of the past five year rule.  You could even rent the home for 10 years, and then move back for two years, and you would qualify for the exclusion. (However at that point, you would run into something called the “nonqualified period” rule which will put a limitation on the amount of gain that you can exclude. That’s a little too complicated to go into right now.)

 

If you qualify for the exclusion when you sell the home, then part of your gain will be tax-free. If you don’t qualify for the exclusion, then all of your capital gains are taxable.  This is only an issue that comes up with the sale of your personal home, because you always pay capital gains tax on the sale of a commercial property. You basically have a three-year time window from when you move out of the house to decide what you’re going to do with the house.

 

 

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
mowmowme
Level 3

Buying 2nd property before selling first home

Thank you! I appreciate the insight!

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