Converting Vacation Home to Primary Retirement Home

[poolshark333]

I bought a 2nd home on Cape Cod, MA in September 2020. We spend less than 14 days per year there as a vacation home and rent it out the rest of the time. When we retire in Sept 2024, we will sell our current primary home and make this our "final" home. We will stop renting it out and make it our full time primary residence/home. Let's say in 2024 (assuming no tax law changes) we have a Schedule E carryover loss of $10k and a total depreciation over the years of say $100k and we no longer rent out the home after Sept 2024. 

1) Let's say we live in the home until Sept 2030 and decide to sell it at that time: so rented for first 4 years and then a primary home for 6 years. My wife and I sell the home at that time (and move into a retirement community) for an overall gain of $550k (and assuming there still is the $500k MFJ Exclusion), will we still get the $500k exclusion and have a capital gain of $50k ($550k-$500k)? What happens to the $100k of depreciation that we accumulated from 2020-2024?

2) Other option is: We just stay in this "final" home and die (well, that just sounded morbid writing that): In this case, I believe the home gets a stepped up basis and any accumulated depreciation (from the early rental years) is zeroed out... So our kids can sell the home after we pass without any real tax consequences, correct?

[Anonymous_ · Accepted solution]

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@poolshark333 wrote:

....will we still get the $500k exclusion and have a capital gain of $50k ($550k-$500k)? 

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You will have a period of non-qualified use (2020-2024) which will not be eligible for the exclusion. The period from 2024-2030 would be eligible for the exclusion, however.

See https://www.irs.gov/publications/p523#en_US_2021_publink100072923

In other words, the gain attributable to the 2020-2024 period would not be eligible while the gain attributable to the 2024-2030 period would be eligible (e.g., roughly, 6/10 (or 3/5) of the gain would be eligible for the exclusion).

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@poolshark333 wrote:

 What happens to the $100k of depreciation that we accumulated from 2020-2024?

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The $100k in accumulated depreciation will be excluded from your net gain that is eligible for the exclusion and subject to depreciation recapture (unrecaptured Section 1250 gain). That $100k figure will be taxed at your ordinary income tax rate (but the maximum tax rate is 25% on that $100k).

[Anonymous_ · Accepted solution]

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@poolshark333 wrote:

....the home gets a stepped up basis and any accumulated depreciation (from the early rental years) is zeroed out... 

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That is correct; accumulated depreciation disappears and the property receives a stepped-up basis (to its fair market value on the date of death) in the hands of your kids. 

[Mike9241]

do not do what some others might do and place your kids' names on the title now. they will end up owning part of it and will get no step up in basis for that portion. there are other options like a life estate, putting the house in trust with the kids as beneficiaries, etc. whatever you do should be discussed with a lawyer or estate planner. certain options will allow probate to be avoided.  

[poolshark333]

so for the $550k gain: The depreciation hits first: so the first $100k of accumulated depreciation is subject to "depreciation recapture" of $100k x 25% (lower of 25% or my tax rate) = $25k (max) tax. Which leaves $450k ($550k - $100k): so $450k x 4/10 or $180k is considered non-qualifying use and is subject to capital gains tax (so say 15%) or $180k x 15% = $27k capital gains tax. The remaining $450k x 6/10 or $270k is considered qualifying use and is eligible for the $500k home sale exclusion (meaning: no taxes on this $270k) .... so bottom line: $25k + $27k = $52k in taxes due to the $550k gain on the sale of my home, correct?

For completeness: I originally stated that I had a carryover loss of $10k. Since I no longer rent out my house, this $10k is basically "lost"... it can't be used to write-off anything (because I have a residual loss with no rental income), correct? These numbers are hypothetical but what matters most is ensuring that the process/understanding is correct 🙂

I appreciate the help so far!! You all are imparting knowledge which I appreciate greatly!

3) So given what I have learned: If I move out of the house and rent it for 3 more years starting 2030, then I meet all of the home tests and would qualify for the full $500k home exclusion (the non-qualifying / qualifying years don't enter into the home exclusion equation with this scenario) ... but I will still owe the "depreciation recapture" with 3 more years of depreciation accumulated

[Anonymous_]

You will still have non-qualifying use in that latter scenario because you moved into the home that was formerly used as a rental. 

Your suspended passive losses should be released on the taxable sale to a third party.

There is a good site (link below) that posits a few hypotheticals.

https://www.merriman.com/wealth-preservation/planning-on-moving-back-into-your-rental-in-the-future-...