Section 121 exclusion rental to new construction primary home

[pmadrid]

I am buying a house next month with a rental on it primarily for the land value (urban Houston). There is a month to month tenant on the property which I will keep to offset holding costs while I design the home and I close on my bank loan for new construction. The hold time will likely be 4 months until the new construction loan closes. At that point I'll kick out tenant, tear down/move the house and build new construction which I will move into about 12 months later. I plan to live in the house 2-3 years and sell for a tax free profit from a section 121 exclusion since it will be my primary house.

I have multiple rent homes some generating a tax profit by now so writing off expenses on the 3-4 month hold cost at this rented house is worth something to me. Appraiser said structure is worth $5k so my depreciation is negligible in this timespan. Haven't found this situation online yet as most people don't tear down a rental but this is in a HCOL urban neighborhood where new construction comps are high and I got a good deal on the lot.

My questions are:

1) Assuming the timeline above, 4 months rental, 12 months personal home construction, 24 months primary residence then sale for 121 exclusion, how does the non-exclusion-eligible taxable portion prorate? 4/(4+12+24) = %10 of profit to be Long Term gains taxed? Or because the original structure is worth basically nothing and I'm building new is 100% of the profit eligible for 121 exclusion since I will live there 2+ yrs? Does the construction period count as part of my 2 yr test for 121 exclusion?

2) I have other rental properties that I just Schedule E and that's it. So do the rental losses get to offset other Sch E income when I tear down and build new? (assuming I Schedule E this property for the 4 months it's a rental)

3) is this all too much headache and is the $800 bucks a month income not worth the blip/headache to my Schedule E portfolio even though taxes, interest etc could be a write off for those months?

Thanks!

[Carl]

If you will be renting out the property for less than one year for the entire time you own it, (in your case, 4 months as a rental) and the *ENTIRE* period of rental will start in the current calendar year, and end in that *same* calendar year, then you are not required to depreciate it.

To achieve that, when you enter the property into the SCH E section of the program you make your COST and COST OF LAND *exactly* the same. Then nothing gets depreciated while retaining your cost basis.

Take special note that if in the future you rent the property or *any* portion of it for one single day in another tax year, then your period(s) of rental have crossed tax years and you are required to take depreciation for the entire cumulative time it was a rental.

[pmadrid]

Thanks for clarifying on the depreciation to enter into turbo tax. how about on the section 121 home sale exclusion. How is that prorated if at all? i am building the new home (and technically refinancing) for my primary residence and will occupy it for 2 years. do i get to have the entire Section 121 when i sell?