By Kasey Rosen, Manager
Since members of the military are often moving because of their work, it is common for military families to purchase a home only to leave a few years later for a new station. Given the volatile housing market and many homeowners wanting to gain equity in their home, it is common to convert the home to a rental home property while you are away. With proper planning, your home can still qualify for the primary residence exemption. Tax-wise there are several things to keep in mind with respect to the property as you convert it to an income earning rental.
Normally, taxpayers are allowed to exclude $250,000 ($500,000 for a married couple filing jointly) on the sale of their primary residence if they owned and used the home as their primary residence for at least two of the last five years before the date of sale. Military members can choose to suspend the five-year test period if they are on qualified official extended duty. You are on qualified extended duty if: you are called or ordered to active duty for an indefinite period or a period of more than 90 days, you are serving at a duty station at least 50 miles from your main home or lastly, you are ordered to live in government quarters. The period of suspension cannot last more than 10 years. It’s important to know that you cannot suspend the five-year test for more than one property at a time.
Here is a list of five significant factors to keep in mind if you have converted your primary residence to a rental while you are away:
- Are you currently filing the required federal and state income taxes for the rental property? Once the home is converted to a rental property, the income needs to be reported on your 1040 form to the state where the property is located. Even if the property is generating a loss, you are still required to report it.
- If your rental is generating a loss you may be able to deduct up to a $25,000 loss if your modified adjusted gross income is less than $100,000. Even if you cannot deduct your losses in the current year you can carry forward your passive losses as they will benefit you when you sell the property.
- Are you depreciating the cost of the home? The cost of the rental home is depreciable over 27.5 years (this does not apply to the cost of the land). Your rental income, expenses, and related depreciation should be reported on Schedule E of your 1040 form.
- Normally, when a rental property is sold, you pay tax on any gain. Since you previously used your home as your primary residence and you can suspend the five-year use and ownership test, you may be able to exclude all or part of your gain on the sale.
- Consider the timing when you’re ready to sell your property. Remember the requirement to have it qualify as a primary residence, otherwise the entire gain will be subject to tax. If you do meet the requirements to exclude the gain under the sale of the primary residence, you still need to consider the depreciation that was taken, as it is subject to recapture. Since you have received a tax benefit over the years from deducting the depreciation, you will need to include this amount as income in the year of the sale. This is applicable even if you meet the requirements for excluding the gain under your primary residence.
With knowledge of the rules and proper planning for rental and sale of your home, you can alleviate some of your tax burden. As always, you should consult your tax advisor if you have any questions or need advice.
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