Buying 2nd property before selling first home

[mowmowme]

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!

[xmasbaby0]

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).

• If you are using online TT, you need Premier or Self-Employed software to report the 1099-S
• .https://ttlc.intuit.com/questions/1901135-i-sold-my-home-at-a-loss-is-this-deductible

[mowmowme]

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]

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]

Thank you! Very helpful!

[rjs]

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@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. 

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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 · Accepted solution]

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.  

[mowmowme]

@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]

@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]

@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.

[mowmowme]

Thank you! I appreciate the insight!

[JARHEAD1960]

I BOUGHT OUR NEW HOME IN JUNE 2021FOR 379,900.OUR OLD HOME WAS SOLD IN AUG OF 2021 FOR 375000 AFTER OWNING IT FOR 26 WEARS.WHAT DEDUCTIONS DO I TAKE?

[AnnetteB6]

Since your homeownership overlapped, you will be able to claim your property taxes paid during 2021 for either home as well as mortgage interest for either home.  

Since you owned and lived in the old home for at least 2 of the last 5 years prior to the sale of the home, then up to $500,000 (Married Filing Joint) or $250,000 (Single) of any gain on the sale can be excluded.  

You may need to enter the details of the sale of your home in TurboTax, but if you qualify to exclude all or part of any gain on the sale of your main home, it will not actually be reported on your tax return or be a taxable transaction.  

Take a look at the following TurboTax article for more information about the home sale exclusion and how to enter the sale of your home into your tax return:  Is the money I made from a home sale taxable?

There will be a link on the page in TurboTax for further information about whether you need to enter any details about the sale into your return.  Follow the instructions in that link to decide what to do next.  

@JARHEAD1960

[Opus 17]

@JARHEAD1960 

When you buy and sell personal property, including your home, the two transactions are completely separate. The old rule about postponing tax on the capital gains from selling the old house when you buy a new house was changed in 1997.

For the sale of the prior home, we have to keep separate the idea of tax deductions and capital gains.

If you sold the home for more than you paid, you have a capital gain. That is usually taxable. However, you can exclude the first $250,000 of capital gains from tax, or $500,000 if you are married filing jointly, as long as this was your main residence and you owned it and lived there at least two years of the past five years.  However, you would be required to pay some capital gains tax if you have ever use the home as a home office or taken a business deduction or a casualty loss, even if you qualify for the exclusion.  You can enter the sale in TurboTax under “sale of your home“. If you qualify for the exclusion, TurboTax will tell you that you don’t even need to report it on your tax return.

As far as deductions go, you will deduct the normal mortgage interest that you actually paid up to the date of sale.  If you paid points on the mortgage when you bought the home and you were spreading the points out over the life of the loan (instead of deducting them as a lump sum when you bought the home), then you can now deduct the remaining unused points in the year you sell the home.  You can deduct property taxes up to the day you sold the home, but not the entire amount you paid the government.  For example, if you paid your property taxes on January 15 for the entire year, and you sold the home in August, then the buyer should have given you a credit on your closing statement for the taxes running from August to December when the buyer would be the owner of the home.  Even if you did not get such a credit, you can only deduct the taxes up to the day you sold the home.

And far as buying a new home, there are no special deductions or credits, and you don’t report the purchase in TurboTax.  However, there are some special rules regarding mortgage and property tax deductions.  You can deduct property taxes for the days that you owned the new home, even if you did not pay them. For example, if the seller paid the property taxes in January for the entire year and you bought the home in June, you can deduct the property taxes paid from June to December as if you paid them directly to the government.  Usually, you will pay a credit to the seller for these taxes, but even if you did not, you can deduct them as if you paid them.

When you closed, you paid daily mortgage interest to the closing bank from the date of the purchase to the end of the month. That interest is deductible even if it is not included in the total reported on the 1098 from the bank that is servicing your mortgage.

If you paid points to get a discount on the mortgage interest rate, those points are usually deductible in the year that you bought the home. If you tell TurboTax you paid points, TurboTax will ask some qualifying questions and will determine for you if you must spread out the points over the life of the loan or may deduct them all at once.

If you paid a lump sum premium for mortgage insurance (MIP or PMI) as part of your closing, you can deduct that over seven years (84months) as a mortgage insurance deduction.  This is in addition to any mortgage insurance premium that you pay monthly which is reported on your 1098. TurboTax will not figure out the deductible portion of your lump sum mortgage insurance premium. You will have to figure it out yourself. If you closed in June, then you can claim 6/84 of the total for this year.  If you have a VA loan and paid a VA funding fee, or you have a rural housing loan and paid the insurance fee for that loan, the lump sum is fully deductible this year.