Q: Fifteen years ago I bought a house in Florida for $86,000. Two years later we moved to Missouri and I have rented out the house for the past thirteen years, depreciating it every year.
The property is currently worth $250,000. I would like to sell the house and be able to put the equity into my current house without paying too much in capital gains tax.
One idea I had was to sell the rental house in Florida and buy a rental house in Missouri. I could then rent that house out for one year only and then move into that house for two years.
The only rule I have heard about is that if you lived in your home at least 2 out the last 5 years you do not have to report capital gains unless it is over $500,000 for married couples. I would then be able to sell both homes and invest all of the money in a new house without paying capital gains tax.
Would this work?
A: The only way to completely defer paying capital gains tax on your property is to do a 1031 tax free exchange, also known as a Starker Trust.
There are specific rules and regulations and time issues that you must live by with a 1031, and you’d be wise to look up those rules (try TaxPlanet.com) before embarking on the process. A real estate attorney, or a closing agent from a title or escrow company, can help you through the 1031 process. You will need an independent third party to hold the proceeds until the exchange is completed. The new property must be worth at least what the old property sells for.
As for turning the investment property back into a personal residence, you can do that, but when selling it, you will have to pay a portion of your profits back to the government to recapture the depreciation. Your tax preparer can help you further.